Prior to enactment of the Affordable Care Act, employee health benefits provided through an insurance contract (i.e., fully insured benefits) were not subject to any income-based nondiscrimination requirements under the Tax Code. Thus, an employer could provide more generous health insurance benefits to executives or other highly compensated individuals through the purchase of individual or group insurance policies. As a reesult of the Act, that will soon change.
By contrast, self-funded plans, sometimes referred to as “self-insured” or “administrative-services-only” plans, were (and continue to be) subject to the nondiscrimination requirements of Code Section 105(h). Under that provision, if a self-funded health plan discriminates in favor of “highly compensated individuals” (or “HCIs”) — generally, the owner(s) and the highest-paid 25 percent of all employees — all or a portion of the health care expenses paid or reimbursed under the plan on behalf of those HCIs will be taxable as ordinary income.
The Act generally extends these nondiscrimination requirements to insured health plans (other than “grandfathered” plans), but with an important twist. Under a new section of the Public Health Service Act (“PHSA”), as well as a new provision of the Tax Code making that section of the PHSA applicable to all types of employers, insured plans must now satisfy the nondiscrimination requirements of Code Section 105(h) as if that section applied to those plans. However, these insured plans are not actually subject to Section 105(h).
This distinction is significant. If an insured plan violates the Section 105(h) requirements (by favoring HCIs in terms of either eligibility or benefits), the benefits provided under the plan will not be taxed to the HCIs. Instead, the plan administrator will be subject to a penalty (under the HIPAA provisions of the Code) equal to $100 per day per affected participant, up to an annual limit of $500,000 per year. With certain exceptions, small employers (those with 50 or fewer employees) are not subject to this penalty tax.
As noted above, this new provision applies to insured health plans other than those in existence on March 23, 2010 (i.e., “grandfathered” plans), and solely to plan years beginning on or after September 23, 2010. Consequently, plans that discriminate in favor of HCIs will now fall into one of the following three categories:
• Self-funded plans (regardless of their status as “grandfathered” plans) will continue to be subject to Code Section 105(h), under which discriminatory benefits are taxable to HCIs;
• Insured plans that are “grandfathered” may continue to discriminate in favor of HCIs without consequence; and
• Insured plans that are not “grandfathered” (and that are sponsored by employers with more than 50 employees) will be subject to a significant excise tax if they discriminate in favor of HCIs in any plan year beginning after September 23, 2010.