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IRS rules on health reform excise tax may lead to rethink of group plan design

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Many employers are likely to redesign the fastest growing group health plan design — high-deductible plans linked to health savings accounts — in the wake of forthcoming Internal Revenue Service regulations.

Those rules will deal with one of the last areas of the 2010 health care reform law to take effect: the “Cadillac” tax that will impose a 40% excise tax on group health plan premiums that exceed $10,200 for single coverage and $27,500 for family coverage in 2018.

Third-party claims administrators will pay the excise tax for self-funded employers. Insurers will pay the tax for fully insured employers. TPAs and insurers are expected to seek reimbursement from employers.

The specter of that tax, which a 2014 Towers Watson & Co. survey found could hit nearly half of employers, has helped fuel employer interest in replacing traditional health plans with much less costly HSA-linked high-deductible plans, also known as consumer-driven health plans.

Employees can make pretax contributions, with a maximum this year of $3,350 for single coverage and $6,650 for family coverage, to the HSAs to pay uncovered health care expenses.

But in its notice last week laying out “potential” approaches in its future regulations dealing with the excise tax and seeking comment, the IRS said employees' pretax contributions to HSAs will be included to determine if the total plan cost will trigger the excise tax.

“Treasury and IRS anticipate that future proposed regulations will provide that employer contributions to HSAs” will be included in plan calculation costs, and employees' pretax salary reductions would be “treated as employer contributions” for plan cost calculations.

While the IRS' intent is not a surprise, there had been some hope it might take a different approach. That is because the Patient Protection and Affordable Care Act does not explicitly say that employees' pretax contributions to HSAs are to be included in calculating plan costs.

Instead, the law refers to only employer contributions, leading some to believe that pretax contributions might be excluded.

“It was hoped that employees' pretax contributions would not be treated this way,” said Rich Stover, a principal at Buck Consultants at Xerox in Secaucus, New Jersey.

If the IRS does adopt rules requiring employers to include employees' pretax HSA contributions in calculating plan costs, employers are likely to redesign their high-deductible plans, such as capping pretax contributions or allowing only after-tax contributions to reduce the likelihood of triggering the excise tax, experts say.

“You would see a change in contribution strategy in which contributions would have to be made on an after-tax basis,” said Steve Wojcik, vice president of public policy at the National Business Group on Health in Washington.

“Some employers will consider amending their HSAs to eliminate employee salary reduction contributions and permit employee HSA contributions only on an after-tax basis in order to reduce excise tax exposure,” said Anne Waidmann, a director at Pricewaterhouse-Coopers L.L.P. in Washington.

While after-tax HSA contributions would be excluded when calculating plan costs, employees would be able to achieve nearly the same tax result as pretax contributions by deducting the after-tax HSA contributions on their individual tax returns, Ms. Waidmann said.

Still, such a switch from pretax to after-tax contributions would erode tax savings for employers and employees. That is because while employees can take a tax deduction for their after-tax HSA contributions, their salaries — for tax purposes — are not reduced in computing FICA taxes. That 7.65% tax on wages is paid by both employers and employees.

While employers may redesign their CDHPs, they are unlikely to move away from the rapidly growing health plan design entirely, experts say.

CDHPs “make employees more conscious of health care costs, making them better consumers of health care services, which in turn helps to keep costs down,” Mr. Wojcik said.

In fact, changes in the tax treatment of employees' pretax HSA contributions may accelerate employer adoption of CDHPs before the excise tax takes effect in 2018, he said.

“You may want to pull the trigger sooner rather than later,” Mr. Wojcik said, referring to employer adoption of CDHPs linked to HSAs,

And employer adoption of the plans has been rapidly growing. Last year, 41% of employers with at least 500 employees offered a CDHP linked to an HSA, up from 32% in 2013, according to a Mercer L.L.C. survey.

Meanwhile, benefit lobbying groups and others say they will not give up and will urge the IRS to exclude pretax HSA contributions in its excise tax regulations.

“We will continue to press the IRS to change this,” said Gretchen Young, senior vice president of health policy at the ERISA Industry Committee in Washington.

“Everyone with these types of plans wants the HSA contribution — of any sort — to be disregarded” in cost calculations, said Andy Anderson a partner at Morgan, Lewis & Bockius L.L.P. in Chicago.