April 5‚ 2011

IRS Issues Guidance on W-2 Reporting of Health Care Costs

By Patricia A. Moran

The Patient Protection and Affordable Care Act of 2010 (the Act) requires employers to report the cost of employer-provided health coverage to employees on annual W-2 forms. The purpose of this provision is to provide "useful and comparable consumer information to employees on the cost of their health care coverage." On March 29, 2011, the Internal Revenue Service (IRS) provided welcome guidance on this reporting requirement in Notice 2011-28 (the Notice), including guidance on the employers subject to the reporting, the types of coverage to be reported, and the calculation of the reported amounts. This alert describes the guidance set forth in the Notice.

Background

Internal Revenue Code Section 6051(a) generally requires employers to annually provide a statement of compensation (the W-2) to employees. The W-2 must be issued on or before January 31st of the year following the year in which the compensation is paid; an employee who terminates during a calendar year is also entitled to a W-2 within 30 days of the employee's written request.

The Act added new Code Section 6051(a)(14), which requires the aggregate cost of applicable employer-sponsored health coverage to be included in the information reported on the W-2. The new requirement does not change the taxation of the employer-sponsored coverage, but rather is meant to provide useful cost information to consumers.

Although this new reporting requirement was originally intended to take effect for tax years beginning January 1, 2011, the IRS delayed the effective date of the new reporting requirement to tax years beginning January 1, 2012, in order to provide employers with additional time to prepare for compliance.¹ As discussed below, the Notice provides further guidance to help employers adapt their payroll and reporting processes for the new requirement.

The IRS stresses that the Notice provides "interim" guidance only. Thus, while employers may rely on this guidance for the time being, elements of the guidance are subject to change.  Employers will, however, receive adequate notice of any such changes.

When Reporting Must Begin

The Notice confirms that employers are not required to report the cost of health coverage on any W-2 forms required to be furnished to employees prior to January 2013 (i.e., the W-2 forms reporting 2012 compensation). The Notice also provides that an employer is not required to report health care costs on W-2 forms requested by employees prior to the end of a calendar year due to the employee's termination during that calendar year. However, any employer who chooses to voluntarily report health care costs prior to such times may rely on the guidance contained in the Notice.

Who Must Report

All employers that provide "applicable employer-sponsored coverage" (see below) under a "group health plan" are subject to the reporting, including federal, state, and local government entities; churches and other religious organizations; and employers that are not subject to the COBRA continuation coverage requirements.² The Notice provides two exemptions. An employer need not report if the following applies:

·         The employer was required to file fewer than 250 Forms W-2 for the preceding calendar year; or

·         The employer is a federally recognized Indian tribal government.

The Notice provides additional guidance with respect to employees who have more than one employer during a calendar year. In general, each employer providing coverage to the employee must report the cost of the coverage it provides. Where a common paymaster reports coverage for several related employers, however, each related employer need not also report the coverage. Predecessor and successor employers must each report coverage separately, unless the successor opts to report predecessor coverage pursuant to IRS procedures.³

Where to Report

Costs will be reported on Form W-2 in box 12, using code DD. Costs need not be reported on Form W-3 (used for the employer's transmittal of Wage and Tax Statements to the Social Security Administration).

What Coverage Must Be Reported

Under new Code Section 6051(a)(14), the aggregate cost of "applicable employer-sponsored coverage" must be reported.

Applicable employer-sponsored coverage means coverage under any "group health plan" made available to the employee by an employer that is excludable from the employee's gross income under Code §106, or would be so excludable if it were employer-provided coverage (within the meaning of such §106). A "group health plan" includes any insured or self-insured plan or, or contributed to by an employer or employee organization to provide health care (directly or otherwise) to the employees, former employees, the employer, others associated or formerly associated with the employer in a business relationship, or their families.

Exemptions. "Applicable employer-sponsored coverage" does not include the following:

1.     Any coverage for long-term care,

2.     Coverage described in Code § 9832(c)(1) (other than subparagraph (G) thereof (coverage for on-site medical clinics); i.e., the following:

·         Coverage only for accident, or disability income insurance, or any combination thereof;

·         Coverage issued as a supplement to liability insurance;

·         Liability insurance, including general liability insurance and automobile liability insurance;

·         Workers' compensation or similar insurance;

·         Automobile medical payment insurance;

·         Credit-only insurance; or

·         Other similar insurance coverage, specified in regulations, under which benefits for medical care are secondary or incidental to other insurance benefits.

3.     Any coverage under a separate policy, certificate, or contract of insurance that provides benefits substantially all of which are for treatment of the mouth (including any organ or structure within the mouth) or for treatment of the eye, and

4.     Any coverage described in § 9832(c)(3) the payment for which is not excludable from gross income and for which a deduction under § 162(l) is not allowable. The types of coverage described in § 9832(c)(3) include the following, provided that such coverage is offered as independent, noncoordinated benefits:

·         Coverage only for a specified disease or illness; and

·         Hospital indemnity or other fixed indemnity insurance.

What Costs Must Be Reported

Generally, both the portion of the cost paid by the employer and the portion of the cost paid by the employee for the applicable employer-sponsored coverage must be reported, regardless of whether the employee paid for that cost through pre-tax or after-tax contributions. Costs of coverage must be included even if a portion of the cost is taxable to the employee. This rule is likely to come into play where insured plans are required to cover same-sex spouses, domestic partners, and/or adult children under state law, but such coverage is not exempt from income under Code Section 106.

The Notice separately provides that, while some types of plans are indeed "applicable employer sponsored coverage," the costs of coverage under these plans need not be reported. These excludable costs include the following:

1.     The amount contributed to any Health Reimbursement Account (HRA), Health Savings Account (HSA), or Archer MSA

2.     The amount of any employee contribution to a health flexible spending arrangement (provided, however, that any employer contributions to such an arrangement, such as in the form of flex credits, may need to be reported as described in more detail below)

3.     An employer's contributions to a multiemployer plan

4.     Costs of coverage under a stand-alone dental plan or a vision plan

5.     Costs of coverage provided under a self-insured group health plan that is not subject to any federal continuation coverage requirements

6.     Costs of coverage provided by the federal government, the government of any state or political subdivision thereof, or any agency or instrumentality of any such government, under a plan maintained primarily for members of the military or for members of the military and their families.

A special rule governs the extent to which amounts provided under a health care flexible spending account (FSA) must be included in aggregate reportable cost. The Notice explains that amount of a health FSA generally equals the amount of an employee's salary reduction for the plan year, plus the amount of any optional employer "flex credits" that the employee elects to apply to the health FSA.

For purposes of determining the aggregate reportable cost, the amount of the employee's health FSA is reduced (but not below zero) by the employee's salary reduction election. So if the amount of salary reduction (for all qualified benefits) elected by an employee equals or exceeds the amount of the health FSA for the plan year, the employer does not include the amount of the health FSA for that employee in the aggregate reportable cost. But if the amount of the health FSA for the plan year exceeds the salary reduction elected by the employee for the plan year, then the amount of that employee's health FSA less the employee's salary reduction election for the health FSA is included in the aggregate reportable cost.

Calculating Costs

In general, the Notice contemplates that costs will be calculated in the same fashion as full COBRA premiums (less the allowable 2% COBRA administration fee), i.e., the following:

·         For insured plans, the reported cost is the premium charged by the insurer for that employee's coverage; and

·         For self-insured plans, the employer must calculate the COBRA applicable premium in a manner that satisfies the requirements under § 4980B(f)(4).⁴

The Notice provides additional guidance as follows:

·         COBRA Subsidies. Even if an employer does not charge the full COBRA premium (e.g. subsidizes COBRA) for some of its former employees, the full COBRA premium should be used as the basis for the 6051(a)(14) reporting.

·         Composite Rates. Where an employer charges a "composite" rate (e.g. "family" coverage), the employer need only report the premium charged for the composite rate. For example, an employer may report the same amount for each employee electing "family" coverage, even though the number of family members covered may vary from employee to employee.

·         Mid-year Coverage Changes. If an employee changes coverage during a calendar year, commences or terminates coverage during a calendar year, or terminates employment during a calendar year, an employer may use any reasonable method to determine the reportable cost for such period, provided that the same method is used for all employees with coverage under the plan.

·         Highly Compensated Employees. The cost of applicable employer-sponsored coverage is not modified because of excess reimbursements of highly compensated individuals that are included in gross income under § 105(h); that is, an excess reimbursement that is included in income is neither added to the cost of coverage, nor subtracted from the cost of coverage, in determining the aggregate reportable cost.

·         Retirees and Former Employees. Code Section 6051(a)(14) does not require an employer to issue a W-2 to an individual to whom the employer is not otherwise required to issue a Form W-2, such as a retiree or other former employee receiving no compensation required to be reported on a Form W-2.

More Guidance Expected

As noted above, the Notice is meant to provide transitional guidance, and some elements of the guidance are subject to change. The following elements of the Notice's guidance are specifically marked as "transitional":

·         Relief for employers filing fewer than 250 Forms W-2;

·         Relief with respect to certain Forms W-2 furnished to terminated employees before the end of the year;

·         Relief with respect to multiemployer plans;

·         Relief for HRAs;

·         Relief with respect to certain dental and vision plans; and

·         Relief with respect to self-insured plans of employers not subject to COBRA continuation coverage or similar requirements.

Employers will, however, receive adequate notice of any such changes. To the extent that future guidance applies the reporting requirement to additional employers or categories of employers, additional types of coverage, or otherwise applies the reporting requirement more expansively, that guidance will apply prospectively only and will not apply to any calendar year beginning within six months of the date the guidance is issued.

Next Steps

While the new W-2 reporting will not be required for some time, employers are urged to begin planning for these changes by reviewing payroll processes, determining which plans are subject to reporting, and identifying appropriate staff (finance, payroll, human resources) who will assist in implementing these new requirements.

If you have any questions about this alert, please contact the author or your Mintz Levin attorney.

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Endnotes

1  See IRS Notice 2010-69.

2  The continuation coverage requirements of the Consolidated Budget Reconciliation Act of 1986, better known as "COBRA", are found in Code Section 4980B.

3  See Rev. Proc. 2004-53.

4  4980B(f)(4)(B)(i) provides that the COBRA premium for a self-funded plan, for a period of coverage, is "a reasonable estimate of the cost of providing coverage for such period for similarly situated beneficiaries which (I) is determined on an actuarial basis and (II) takes into account such factors as the Secretary [of the Treasury] may prescribe in regulation." 4980B(f)(4)(B)(ii) goes on to say that costs are determined based on past costs plus inflation. Since no regulations have elucidated these requirements, self-funded plans are left to calculate COBRA premiums in good faith compliance with a reasonable interpretation of 4980B(f)(4)(B).