Subsidized Post-Termination COBRA Benefits
Nancy Campbell recently wrote a newsletter that discussed how health care reform impacts COBRA. One of the issues that Nancy addressed is subsidized COBRA and severance arrangements. The purpose of this blog is to dive deeper into the issues employers should consider when providing subsidized post-termination COBRA benefits.
• Providing Post-Termination Medical Benefits on an After-Tax Basis. Sections 105 and 106 of the Code exclude employer-provided health coverage and benefits from an employee’s gross income if certain requirements are met. One requirement that must be met for self-funded health insurance plans to qualify for this exclusion from gross income is compliance with the nondiscrimination rules of Section 105(h) of the Code. Section 105(h) provides that self-funded plans may not discriminate in favor of highly compensated individuals. Providing subsidized COBRA coverage to an executive employee on terms and conditions more favorable than those offered to other employees likely runs afoul of the nondiscrimination rules of Section 105(h) and could cause the executive to be taxed on the value of the benefit provided (i.e., the value of the services provided under the plan). For example, if an executive that participated in a discriminatory self-funded plan incurred a $50,000 surgery bill, the executive could be required to include the entire $50,000 in gross income. One strategy that employers have used to avoid Section 105(h) nondiscrimination issues in the self-funded context is to provide the subsidized COBRA coverage on an after-tax basis by imputing income equal to the value of the premium subsidy and/or requiring the employee to pay his or her share of the premium on an after-tax basis.
The Health Care Reform Act added a nondiscrimination rule for fully insured health plans similar to the Section 105(h) nondiscrimination rule. Although the IRS has stated that insured health plans need not comply with the nondiscrimination rule until it issues further guidance, employers that sponsor insured health plans may wish to consider providing subsidized post-termination COBRA coverage on an after-tax basis. Another alternative is to provide the employee with an equivalent amount of taxable cash compensation. The employee could then decide whether he or she wants to purchase COBRA through the employer’s plan or purchase an individual policy through a Health Care Exchange.
• Section 409A of the Code. Severance agreements that call for the reimbursement or payment of subsidized COBRA coverage are subject to Section 409A of the Code unless an exception applies. Section 409A does not apply to the following types of medical reimbursement arrangements:
• Medical reimbursement arrangements that provide benefits or reimbursements that are excluded from income under Sections 105 and 106 of the Code are not subject to Section 409A. Self-funded arrangements that provide discriminatory benefits do not fit within this exception to Section 409A.
• Reimbursements for post-termination medical coverage are exempt from Section 409A as long as such arrangements provide coverage during the COBRA continuation coverage period (generally 18 months). Subsidized COBRA coverage that extends beyond the COBRA continuation period must comply with Section 409A.
• If an employer provides an employee with taxable cash compensation, the employer may wish to consider structuring the payments to fit within the short-term deferral exception or separation pay exceptions to Section 409A. Another, but perhaps less desirable, approach may be to structure the payments to comply with Section 409A of the Code by making the payments on specified payment dates (or designating specified years for the time of payment).