Health Care Reform Update: Planning Now for Significant 2014 Deadlines
The Affordable Care Act (the “ACA”) makes sweeping changes to the current health insurance landscape. Though some of these changes are already in force, the most significant provisions of the ACA become effective on January 1, 2014. This includes the “pay or play mandate,” the individual coverage mandate, and certain significant taxes and fees that are imposed on employers.
While many employers are already in the midst of planning for these significant changes, other employers have yet to examine how these new requirements will impact business operations, health coverage costs, benefit plan design, and coverage of employees. Employers are required to notify existing employees of their coverage options by October 1, 2013 (See Technical Release No. 2013-02 for a discussion of this notice requirement). Practically speaking, this means that employers must have a compliance plan in place well before the January 1, 2014 effective date of these changes. Given the significant impact of these requirements, and given the fast-approaching deadlines, we have been urging employers to begin analyzing these issues now so they have a strategy in place that will enable them to continue normal business operations while complying with the myriad of complex new requirements. Key decisions that need to be made well in advance of 2014 include:
- Whether to continue offering group health coverage on/after 2014. We have not seen a significant push from employers to completely eliminate their health plans. However, the cost increases in 2014 are significant enough that many employers are analyzing this option and considering it for the future.
- If the employer will continue to offer coverage, what (if any) steps the employer should take to offset the significant cost increases associated with the new requirements. The ACA requirement to provide coverage to all full-time employees will result in a significant cost increase, especially for employers who do not currently provide coverage to these employees. Even if an employer currently provides coverage to all full-time employees, the individual mandate will cause more employees and dependents to enroll, thereby increasing costs by virtue of the “woodwork effect.” There are also significant taxes (e.g., the transitional reinsurance fee and the patient-centered outcomes research fee) that will further raise costs for employers. For many employers, these cost increases are prohibitive. Accordingly, employers should analyze whether it is prudent/necessary to make plan design changes, revise employment practices, implement wellness programs, and/or take other steps to offset cost increases.
- Whether any action needs to be taken to avoid the pay or play penalties. Generally, the pay or play penalties apply to employers that either (a) do not offer coverage to at least 95% of their full-time employees or (b) offer coverage to at least 95% of their full-time employees, but such coverage is either unaffordable or does not provide minimum value. Accordingly, employers need to analyze issues such as:
- Who qualifies as a full-time employee? To make this determination, employers must look at the hours its employees work during a “standard measurement period” beginning in 2013. Accordingly, employers should already be reviewing this issue.
- Is coverage offered to at least 95% of these employees?
- If not, what plan design or employment practice changes must be made to alter this result?
- Does the current plan offer affordable coverage that provides minimum value?
These are just a few of the issues that employers should be working through before 2014 (see this brief presentation for a more detailed four-step analysis). While many of the new requirements are very complex, we believe there is still time to properly analyze these questions and develop a solid compliance strategy that will help control inevitable cost increases, while still complying with the new requirements. However, time is of the essence because 2014 is right around the corner.
Sutardja Decision Shows Employers How to Preserve Stock Option Flexibility In a 409A World
Many commentators were surprised by the recent federal court of claims decision to deny summary judgment in Sutardja v United States. Sutardja, which currently is headed for trial, involves the IRS assessing a public company executive with Code Section 409A penalties, including a 20% additional income tax plus interest, with respect to potentially discounted stock options. What’s surprising isn’t so much the court’s decision, but that the IRS chose this particular fact pattern to assess Code Section 409A penalties. The option grant procedures that the employer followed would not be confused with best practices, but they occurred before Code Section 409A was enacted. The executive and the employer even tried to correct the issue after Code Section 409A’s enactment, despite there being limited other guidance, but the IRS still chose to punish the executive.
We believe that Sutardja offers a couple of lessons for employers. The first is don’t panic—in most cases, executives will still be able to exercise their options when they see fit and thus retain the flexibility to choose when to recognize taxable income. The second is that in order to grant options that provide this type of flexibility, employers need to follow detailed stock option grant requirements under the Code Section 409A regulations. This lesson may be harsh for the executive in Sutardja considering that most of those requirements hadn’t been written yet, but it gives the rest of us a chance to learn from those mistakes. Accordingly, this blog will focus on the opportunities employers have to correct outstanding plan grants and improve grant practices for future grants. We first will provide background on the case itself, highlighting the option grant practices that the IRS punished. Second, we will explain how employers can comply with the stock option grant requirements of Code Section 409A so that executives may retain the flexibility to choose when to exercise those options.
Summer is Coming, But Don’t Forget About the HIPAA Omnibus Rule
Summer is right around the corner, so you are probably thinking about cookouts, pool parties, and vacations. HIPAA is probably the furthest thing from your mind (if not, you probably wish it was). However, before you book those beach vacations, do not forget to mark September 23, 2013 on your calendars, as this is the general deadline for compliance with the new HIPAA Omnibus Rule.
In a recent blog post, we explained how the HIPAA Omnibus Rule alters business associate agreement requirements. Unfortunately for plan sponsors, the impact of these new rules extends beyond business associate agreements. For example, plan sponsors will need to update their Notice of Privacy Practices (“NPP”) to include:
- A description of the types of uses and disclosures of protected health information (“PHI”) that require an authorization;
- A statement that the covered entity is required by law to notify affected individuals following a breach of unsecured PHI;
- A statement informing individuals that a covered entity may contact them to raise funds for the covered entity and an individual has a right to opt out of receiving such communications; and
- A statement that the plan is prohibited from using genetic information for underwriting purposes.
NPPs must be revised by September 23, 2013 for compliance with these new requirements. With respect to the timing and medium of distribution, plan sponsors that generally post NPPs to their websites must (1) post the revised NPP by September 23, 2013 and (2) provide the revised NPP, or information about the material change and how to obtain the revised notice, in the next annual mailing to covered individuals (i.e., during open enrollment). Plan sponsors that do not post the NPP on their website must distribute the revised NPP (or information about the changes and how to obtain the revised NPP) to individuals within 60 days of the changes.
Plan sponsors will also need to update their HIPAA Privacy Policies and Procedures to address these new requirements. For example, you may need to update your HIPAA Privacy Policies and Procedures to:
- Revise the definition of PHI (this should now include genetic information);
- Clarify your policies regarding individuals’ rights concerning their PHI, such as access to records;
- Generally prohibit the sale of PHI (subject to limited exceptions);
- Generally prohibit the use of PHI for marketing purposes (subject to limited exceptions); and
- Generally prohibit the use of PHI for fundraising communications (subject to limited exceptions).
The good news is that the September 23, 2013 deadline is still a ways off, which means you do not have to take your HIPAA compliance materials with you to the beach. However, you should circle this date on your calendar so that you can address these issues when you return. Or, better yet, you can address these issues now so that you have one less thing to trouble your mind while you are soaking up the sun.
Temporary Relief From ACA Provisions Extended To Insured Expatriate Plans
The Departments of Labor, Health and Human Services and the Treasury (collectively, the “Departments”) recently issued guidance in the form of a Frequently Asked Question (“FAQ”) that relates to the applicability of the market reform provisions of the Affordable Care Act (the “ACA”) to certain expatriate health care plans. The issuance of this new FAQ indicates that the Departments recognize that expatriate health care plans face special challenges in complying with certain provisions of the ACA, such as the need to reconcile multiple regulatory regimes that may apply to such plans. In addition, the Departments recognize that in some situations it is possible that the ACA actually may conflict with foreign law requirements.
The new guidance provides that expatriate plans that are fully-insured will not have to comply with certain provisions of the ACA for a limited transition period extending through plan years ending on or before December 31, 2015. For purposes of this transitional relief, an expatriate health plan is defined as an insured group health plan in which enrollment is limited to primary insureds who reside outside of their home country and its associated group health insurance coverage for at least six months of the plan year and any of their covered dependents. No relief is extended to plans that are not insured.
As a result of the guidance, insured expatriate health care plans are not subject to a number of ACA requirements during the transition period, including but not limited to: (a) the extension of coverage for children until age 26; (b) the prohibition of all pre-existing condition limitations; (c) the coverage of preventive health care services on a first-dollar basis; (d) the prohibition against annual and lifetime dollar limits on essential health benefits; (e) the prohibition against waiting periods in excess of 90 days; and (f) the new internal and external claims appeals procedures.
ESOP Dividend Deduction Rule Targeted by Obama Budget Proposal
The just-released Obama budget proposal includes a proposal to eliminate the IRC Section 404(k) ESOP dividend deduction for large C corporations (or at least what the Obama administration describes as large for this purpose). The Obama budget proposal would repeal the deduction for dividends paid with respect to stock held by an ESOP sponsored by a C corporation (excluding C corporations with annual receipts of $5 million or less). The current provisions, as described below, allowing for immediate distribution or use of an applicable dividend would remain intact (although without the corresponding deduction). These distribution and use rules would be moved to IRC Section 4975(f)(7), which currently provides rules for distributions relating to S corporation stock held in an ESOP maintained by a S corporation. This proposal, if enacted, would apply to dividends and distributions that are paid after the date of enactment of implementing legislation.
Corporations generally do not receive a corporate income tax deduction for dividends paid to shareholders. As an exception to this general rule, C corporations are allowed a deduction for dividends paid with respect to employer stock held in an ESOP if certain conditions are met. To be eligible for the deduction, the dividend must be an “applicable dividend.” A dividend will be treated as an applicable dividend if the ESOP provides that the dividend is (a) paid directly to plan participants or their beneficiaries, (b) paid to the plan and distributed to participants or their beneficiaries not later than 90 days after the end of the plan year, or (c) at the election of the participants or their beneficiaries, paid directly to the participants or their beneficiaries or paid to the ESOP and distributed in accordance with (a) and (b) above or paid to the plan and reinvested in qualifying employer securities. In addition, a dividend generally qualifies as an applicable dividend if the ESOP provides that it may be used to repay a loan originally used to purchase the stock with respect to which the dividend is paid. For this purpose, the dividend qualifies as an applicable dividend only to the extent that employer securities with a fair market value of not less than the amount of the dividend are allocated to the accounts to which the dividend otherwise would have been allocated.
The budget proposal points out that current law extends several tax benefits to ESOPs that are in addition to those applicable to other tax-qualified retirement plans. The dividend deduction certainly is one of these benefits. Thus, it can be argued that this difference in tax treatment creates an additional incentive for employers to encourage investment in employer stock through ESOPs. As others have done before, the Obama administration here is arguing that concentration of employees’ retirement savings in company stock subjects those savings to increased risk without necessarily offering a commensurate return. Moreover, the administration believes that to the extent current payments of dividends to ESOP participants can spur a productivity incentive effect, the effect may be more likely in small employer settings. Thus, given the way the administration seems to see it, providing an exception from elimination of the ESOP dividend deduction for smaller corporations makes good sense.
It is too early to determine whether this proposal will be enacted. I would point out that this is projected under the Obama budget to raise approximately $6.5 billion over the 2014-23 window. This number, while perhaps not huge in overall budget terms, might be attractive, if Congress, as appears likely, embarks on a mission to find sources of revenue that do not require changes in income tax rates (or that even permit some lowering of those rates). Accordingly, this one is worth watching.
U.S. Supreme Court decision: U.S. Airways, Inc. v. McCutchen
The United States Supreme Court issued an opinion today in an ERISA case regarding the breadth of Section 502(a)(3) relief, and the common-fund doctrine. While the decision was unanimous on the primary issues, the Court surprised us with a 5-to-4 split on a secondary issue. Overall, the decision in U.S. Airways, Inc. v. McCutchen is favorable for employers sponsoring health care plans. The decision is also favorable for health care plan participants in the aggregate because it allows for control of plan costs, and premiums, at a critical time when plans are gearing up for 2014 health care reform cost increases.
We discussed the facts and prior decisions in this case in considerable detail in a prior blog. You might want to review that blog to put this decision in context. To summarize, a health care plan provided that it would cover expenses caused by a third-party, subject to the condition that the plan be reimbursed from any monies recovered from a third party. (This is a common provision in ERISA health care plans, intended to control costs for all participants and to avoid costly litigation over recovery.) Mr. McCutchen was in an auto accident with another vehicle, and the plan paid $66,866 of health care plan expenses he incurred due to that accident. After Mr. McCutchen recovered funds from the other driver and his own insurer for underinsured motorist coverage, the plan sought reimbursement of expenses it had paid, in accordance with plan terms. He refused to repay anything, and the case headed to court.
Eventually, the U.S. Supreme Court agreed to hear the case to resolve a circuit split on whether “equitable defenses” could override an ERISA plan’s reimbursement provision. Justice Kagan delivered the opinion, joined by four other justices. Applying prior case law (Sereboff v. Mid Atlantic Medical Services, Inc.), the Court first held that in a Section 502(a)(3) action based on equitable lien by agreement, the ERISA plan’s terms govern. Neither general unjust enrichment principles nor specific doctrines reflecting those principles can override the applicable contract. Accordingly, the plaintiff’s argument that double-recovery rules prevailed over plan terms was rejected. The participant was being held to the agreement to reimburse in the event of recovery.
The Court next rejected the Department of Labor’s argument that the common-fund rule has a special capacity to trump a conflicting contract. The common-fund rule provides that “a litigant or lawyer who recovers a common fund for the benefit of persons other than himself or his client is entitled to a reasonable attorney’s fee from the fund as a whole.” The Court found that this rule was treated the same as any other rule: ERISA plan terms prevail.
Then, the Court took a somewhat surprising next step. It found a “contractual gap” in the plan document regarding the cost of recovery. The Court found that the common-fund doctrine provided the best indication of the parties’ intent, requiring the attorney’s fees to be paid before the plan was reimbursed. The Court’s majority thought it was unfair that plaintiff would have been “in the hole” for $866 if the common-fund doctrine had not been applied.
The $866 arose based on four agreements the plaintiff entered into: with the plan, attorney, and two other parties. Another view of the $866, from the other plan participants’ perspectives, is that the $866 was not a hole, but was plaintiff’s gamble that he could pay an attorney a 40% contingency fee on the entire recovery, and keep the approximately $66,000 remaining, rather than repaying anything to the plan.
In a dissent, Justice Scalia (joined by three other justices, including Chief Justice Roberts) agreed with the majority on the primary issues, but disagreed regarding the “contractual gap.” In the dissent’s view, the parties had conceded that the plan provided for full reimbursement, without any contribution to attorney’s fees and expenses. Therefore, the issue of whether the plan was ambiguous as to attorney’s fees was not before the Court, and the Court should not have applied the common-fund doctrine.
What does this decision mean for plan sponsors? U.S. Airways, Inc. v. McCutchen informs us that ERISA plan provisions prevail: health care plan sponsors can write provisions regarding reimbursement from recovery, and participants who accept payment of expenses under those conditions are expected to honor the agreement. The decision also leaves plan sponsors with a decision to make regarding whether to explicitly disclaim the common-fund doctrine in their plan documents. The Court’s majority explained that where a plan rejects the common-fund doctrine, people like the plaintiff would make different judgments. Whether such a change in judgment is a bad thing, or a good thing, is something for plan sponsors to consider as they redesign their health care plans to comply with health care reform.
HIPAA Omnibus Rule Alters Business Associate Requirements for Covered Entities, Business Associates, and Subcontractors
Most covered entities (e.g., health plans and health care providers) are aware that they are obligated under HIPAA to have business associate agreements (“BAAs”) in place with their business associates who use or disclose protected health information (“PHI”) in carrying out their obligations to the covered entity (e.g., third-party administrators, claim processors, etc.). However, covered entities might not be aware that the Department of Health & Human Services (the “HHS”) recently issued the HIPAA Omnibus Rule, which alters the BAA content requirements (and makes other significant changes to HIPAA, which we will discuss in a separate blog entry).
While the new requirements are not a significant departure from the old BAA content requirements, covered entities must review and update their existing BAAs to ensure compliance with the new HIPAA Omnibus Rule. Required changes include:
- Updating the BAA to state that if the business associate is to carry out the covered entity’s obligations under the Privacy Rule (e.g., the provision of Notices of Privacy Practices), the business associate must comply with the requirements of the Privacy Rule that apply to the covered entity in the performance of such obligations; and
- Adding a provision stating that the business associate is directly subject to the Security Rule.
403(b) Plan Sponsors Can Mitigate Risk By Taking Proactive Steps Under New EPCRS Guidance
Legendary UCLA Men’s Basketball Coach John Wooden once asked, “If you don’t have time to do it right, when will you have time to do it over?” If you sponsor a 403(b) plan, the IRS may have helped answer this question for you. In our prior blog, we highlighted the new Employee Plans Compliance Resolution System (“EPCRS”) guidance set forth in Revenue Procedure 2013-12 (the “Procedure”). This procedure also provides new guidance for 403(b) plan sponsors. Most critically, plan sponsors who did not adopt a written plan document by December 31, 2009 may submit a written plan document to the IRS by December 31, 2013, with a 50% reduction in penalty. The discussion below explains more about the new guidance for 403(b) plan sponsors, and how they may mitigate risk in the event of an audit by taking some proactive steps.
Plan Sponsors Have Greater Opportunities to Correct Errors Under New EPCRS
Do you sponsor a qualified retirement plan? If you’re a tax-exempt or governmental employer, do you sponsor a 403(b) plan? If you answered yes to either of these questions, you know that despite having the best administrative procedures in place, it is easy to make mistakes with respect to the plan. If the IRS were to catch these mistakes on audit, it has the potential to disqualify the plan. Fortunately, the IRS has the Employee Plans Compliance Resolution System (“EPCRS”) in which plan sponsors may correct errors voluntarily—sometimes with an IRS filing and reduced penalties, and sometimes with no filing at all.
The IRS recently updated the EPCRS with the release of Revenue Procedure 2013-12 (“the Procedure”). The Procedure is effective April, 2013, but plan sponsors may follow its procedures immediately. The Procedure gives plan sponsors the ability to correct a greater variety of plan errors than they could in the past. It also clarifies correction methods described under prior versions of the EPCRS. Administratively, the Procedure proscribes new forms to file with the IRS and changes some of the fees. Overall though, the Procedure gives plan sponsors a great opportunity to correct plan document and administrative failures before the IRS discovers such errors on audit. We will briefly describe of the major changes or additions in the Procedure below.
The Fiscal Cliff Is Avoided…But More Cliffs Loom In The Horizon
A fall over the dreaded fiscal cliff has been avoided—at least for now. Unless pre-occupied by New Year’s revelry or college football bowl games, all of us are well, and perhaps painfully, aware that Congress managed to by-pass the dreaded fiscal cliff by passing a tax relief bill on January 1, 2013. A very ungainly legislative process came to a merciful end when the Senate passed the legislation in the pre-dawn hours of 2013 by an overwhelming vote of 89-8. Then, after a day of high drama and rumors of Republican intent to amend the legislation and sent it back to the Senate for additional consideration (which would have had uncertain consequences), the House relented and passed the legislation as enacted by the Senate. The vote in the House was 257-167, with 172 Democrats and 85 Republicans supporting the measure. President Obama has signed the legislation into law. It is difficult to watch this spectacle and not be reminded of the old adage “laws are like sausages, it is better not to see them being made”—and without feeling a bit sorry for sausage makers everywhere for being so linked to Congress.
Some of the more significant provisions in the bill are as follows:
- the 10% individual income tax bracket, scheduled to expire at the end of 2012, was extended permanently;
- the 25%, 28%, and 33% income tax rates, also scheduled to expire at the end of 2012, were extended permanently for income at or below $400,000 for individual filers and for income at or below $425,000 for heads of households and $450,000 for married taxpayers filing jointly, and a new 39.6% income tax rate will be imposed above those limits;
- the personal exemption phase-out is permanently repealed for all taxpayers at or below certain income levels ($250,000 for individual filers, $275,000 for heads of households and $300,000 for married filing jointly);
- the itemized deduction limitation is permanently repealed for all taxpayers at or below certain income levels ($250,000 for individual filers, $275,000 for heads of households and $300,000 for married filing jointly);
- the bill permanently extends the 2001 modifications to the child tax credit;
- the bill permanently extends marriage penalty relief;
- the bill permanently extends expanded Coverdell accounts;
- the bill permanently extends the expanded $5,250 exclusion for employer-provided educational assistance;
- the bill permanently extends the expanded student loan interest deduction;
- the bill permanently extends the exclusion from income of amounts received under certain scholarship programs;
- the bill permanently extends the expanded dependent care credit;
- the bill permanently extends the adoption tax credit and the adoption assistance programs exclusion;
- the bill permanently extends the credit for employer expenses for child care assistance;
- the bill continues to provide a $5 million exception for estate tax liability, which is inflation adjusted, and will apply a top tax rate 40 percent to estates of decedents dying after December 31, 2012;
- the bill permanently extends the current capital gains and dividends rates on income at or below $400,000 (individual filers), $425,000 (heads of households) and $450,000 (married filing jointly) for taxable years beginning after December 31, 2012, and applies a 20 % rate on income in excess of those limits;
- effective for years beginning after December 31, 2011, the bill increases the AMT exemption amounts (from $33,750 to $50,600 individuals and from $45,000 to $78,750 for married filing jointly), and allows nonrefundable personal credits against the AMT;
- the bill extends through 2013 the increase (from $125 to $240) in the exclusion from income for employer-provided mass transit and parking benefits, so that it is the same as the exclusion for employer-provided parking benefits;
- the bill extends for two years the provision that permits annual tax-free distributions to charity from an IRA held by someone age 70 1⁄2 or older of up to $100,000 per taxpayer, per taxable year (and includes a provision under which an individual can make a rollover during January of 2013 and have it count as a 2012 rollover);
- the bill extends for two years, through 2013, the research tax credit equal to 20 percent of the amount by which a taxpayer’s qualified research expenses for a taxable year exceed its base amount for that year and provides an alternative simplified credit of 14 percent; and
- the bill permits any amount in a non-Roth account in eligible retirement plans to be converted to a Roth account in the same plan, whether or not the amount is distributable with the amount so converted being subject to regular income tax (plans currently can allow participants to convert their pre-tax accounts to Roth accounts but only with respect to money the participants have a right to take out of the plan).
The bill extends for one year the availability of benefits under the Emergency Unemployment Compensation Program, and continues for one year the benefits under the extended benefit program with a 3-year look-back. The 2% payroll tax holiday was not extended under the bill.
It appears that the only significant employee benefit plan matter covered in the bill is the expanded in-plan Roth conversions (discussed above). This change produces a $12 billion revenue offset, and thus the reason for its inclusion is obvious. Most of the employee benefits industry supports this change, although the hope for many was that it could be held back for the next wave of fiscal cliff negotiations, which essentially starts right after the new Congress is sworn in, as a way to defend against efforts to raise revenue by increasing contribution limits. Employee benefits issues likely will draw some attention in the continuing fiscal negotiations.
Next up are the budget, the expiration of the debt limit and the sequestration (mandatory spending cuts) under the Budget Control Act. In a classic case of kick the can, the bill moves sequestration forward a mere two months. To make things more interesting, the debt limit will expire at about the same time. Battle sides are forming. In comments after passage of the bill, President Obama indicated he plans to seek additional tax revenue through tax reform to partially fund sequestration relief and deal with deficit. Republicans are likely to oppose such a move (some already have said this publicly). There still are more cliffs ahead of us.
