In addition to the challenges employers are already facing in this recession, the American Recovery and Reinvestment Act of 2009 (ARRA) presents another challenge in the form of new laws governing COBRA premiums for certain involuntarily terminated employees. The changes are of interest to employers and employees alike, as they require employers to assist in facilitating significant federally-funded COBRA premium subsidies for qualifying employees (and their covered dependents).
Both the U.S. Department of Labor (DOL) http://www.dol.gov/ebsa/cobra.html and the Internal Revenue Service have recently released preliminary guidance on the new COBRA subsidy requirements. Unfortunately, many questions still remain with new issues arising daily as employers, insurers, and COBRA administrators work to comply with the rules. As a result, we anticipate regulatory guidance on these topics will continue to evolve and expand with additional DOL and IRS releases on these issues. The following is intended to provide a general overview of the key provisions and compliance requirements imposed by the ARRA subsidy changes and current regulatory guidance:
WHO is subject to the new subsidy rules?
The ARRA changes apply to every employer sponsoring a group health plan subject to federal COBRA rules as well as small employers exempt from COBRA but subject to state continuation coverage or “mini-COBRA” rules with involuntarily terminated plan participants from September 1, 2008 through December 31, 2009. Thus, small employers with health plans exempt from federal COBRA rules are required to comply with the new subsidy rules if they involuntarily terminated employees since September 1st.
WHO is eligible to receive the subsidy?
Assistance eligible individuals or “AEIs” entitled to receive COBRA subsidies under ARRA generally include employees involuntarily terminated between September 1, 2008 and December 31, 2009 (and their covered dependents) provided they are otherwise eligible for COBRA continuation coverage and provided they actually elect COBRA.
The ARRA changes are intended to provide limited COBRA premium assistance only to those employees who have been “involuntarily terminated” (for reasons other than gross misconduct). COBRA subsidies are not available for employees entitled to COBRA as a result of other qualifying events (e.g., reduction in hours, death, disability, divorce, etc.) nor are the general COBRA coverage rules or coverage periods otherwise applicable altered by ARRA.
Unfortunately, neither ARRA nor the current regulatory guidance expressly defines the term “involuntary termination” for such purposes. It appears that ARRA intends to limit subsidies to those employees incurring a complete and total involuntary separation from service with their employer during the applicable subsidy period. As a result, this appears to exclude employees who elect to terminate their employment as part of a voluntarily reduction in force (RIF) or special “window” or buy-out programs. (Terminations due to “good reason” or other constructive discharges, however, may nonetheless qualify for COBRA subsidies depending upon the underlying facts and circumstances.)
Not every involuntarily terminated employee will be eligible to receive the subsidy. Significantly, COBRA qualified beneficiaries who are eligible for other group health coverage (e.g., coverage under a spouse’s group health plan) or Medicare are not eligible for the subsidy although they may still generally elect COBRA. Such exclusions impose an enforcement role on employers who, in turn, will likely need to require involuntarily terminated employees to certify they are not eligible for other coverage as part of the election process. Other exclusions apply. For example, it is also not clear from current guidance whether premiums for certain individuals (e.g., domestic partners or non-dependent children) not considered COBRA qualified beneficiaries can be subsidized even though employers may voluntarily permit the individuals to elect continuation coverage under the employer’s plans.
There are also income caps included in ARRA to ensure the provisions do not benefit high income employees. The COBRA subsidy is phased out for individuals with modified adjusted gross incomes exceeding $125,000 ($250,000 for joint filers) and is eliminated completely for those earning more than $145,000 ($290,000 for joint filers). Although former employees with annual incomes exceeding the income caps may elect to receive COBRA subsidies, they will ultimately forfeit the subsidy by having to include all amounts received in taxable income for the applicable year. High income individuals who are relatively certain to exceed the income caps may elect to voluntarily waive their rights to the COBRA subsidy to avoid any tax implications in the future.
WHAT does the COBRA subsidy cover?
The subsidy is intended to reduce the out-of-pocket expenses of AEIs by requiring them to receive COBRA at a fraction of the regular cost. AEIs are required to pay only 35% of the amount the AEI otherwise would have to pay while the remaining 65% of the applicable COBRA premium is covered or “paid” by employers (in the case of self-funded plans and insured plans subject to COBRA where the employer collects COBRA premiums) or by insurers (in the case of certain insured plans not covered by COBRA). Insurers and employers who cover the 65% subsidy amount will be “reimbursed” by the federal government in the form of a credit on their federal payroll (FICA) taxes.
As an example, if an AEI otherwise required to pay the full COBRA premium out of pocket owes $750 per month, the AEI will now be required to pay only $262.50 per month (35% of $750) with the remaining $487.50 (65% of $750) to be covered by the COBRA subsidy. On the other hand, if the AEI received a severance package with the employer covering 50% of total COBRA premiums so that the AEI had to pay $375 per month, the AEI would now have to pay only $131.50 per month (35% of $375) with the COBRA subsidy covering the remaining $243.75 (65% of $375). The employer would not be entitled to any reimbursement of the other $375 it agreed to provide to the former employee as part of the severance package.
As currently structured, the subsidy appears to be limited just to that portion of the COBRA premium required to be paid by the AEI. As a result, employers who have historically paid all or a portion of terminated employees’ COBRA premiums may wish to reconsider such subsidies (at least through 2009) as they will essentially be covering some costs that could be shifted to the federal government. Although it is possible for AEIs to receive both employer and government-subsidized coverage at the same time and for there to be some overlap in the subsidies, current guidance suggests that it is not possible to receive an ARRA subsidy if an AEI has no out-of-pocket COBRA costs.
HOW long does the COBRA subsidy last?
The 65% COBRA subsidy may extend up to a maximum of nine (9) months beginning with the first COBRA coverage period starting after February 17, 2009. In no case, however, will the COBRA subsidy extend beyond an AEI’s regular COBRA coverage period. In addition, the subsidy may be terminated prior to the 9-month maximum period if an AEI is entitled to coverage under another employer-sponsored group health plan or Medicare or if the AEI fails to pay his or her 35% portion of the COBRA premium.
It appears the COBRA subsidy will terminate simply as a matter of the AEI becoming entitled to other group coverage even if the AEI does not actually elect the other coverage. (AEIs have an obligation to notify employers once they cease to be eligible for the subsidy and may be penalized up to 110% of ineligible subsidies if they fail to timely notify employers of alternative coverage eligibility.) Although the subsidy terminates after a maximum of 9 months, qualified beneficiaries may continue COBRA coverage for the full COBRA period (i.e., typically up to 18 months) but will be required to pay 100% of the employee’s portion of COBRA premiums after the subsidy expires.
HOW do employers obtain reimbursement for the subsidy payments?
Employers are generally required to pay or cover the 65% COBRA subsidy up front on behalf of AEIs and then seek reimbursement by claiming a tax credit on their Form 941 (Employer’s Quarterly Federal Tax Return). On February 26, 2009, the IRS released preliminary guidance in the form of Q&As regarding the process for claiming tax credits for their prior subsidy payments. In addition, the IRS also provided revised versions of Form 941 and corresponding instructions reflecting the COBRA tax credit provisions.
In its guidance, the IRS makes clear that an employer may elect to offset its payroll tax deposits on a rolling basis during the quarterly period for COBRA subsidy payments or it may simply make payroll tax deposits in the normal course and claim the subsidy as an overpayment at the end of the quarter. Employers who elect to offset their payroll deposits, however, should exercise caution that they offset deposits only for those individuals who have paid their 35% portion of the COBRA premium or they may inadvertently overestimate their COBRA subsidy amounts. Such overstatements could result in significant withholding tax penalties and interest.
In the event the COBRA premium subsidies exceed the employer’s total taxes owed for the quarter, the subsidy payments will be classified as an overpayment which may be applied to the employer’s next return or requested as a refund. The IRS guidance also confirms that, given the short implementation period, employers will be provided a two-month transition period in which they may seek subsidy adjustments or reimbursements for AEIs who pay the full portion of their COBRA premiums during March and April.
The IRS guidance and the revised Form 941 only require employers to report the amount of COBRA premium subsidies paid and the number of individuals receiving subsidies over the applicable period. Employers are not required to submit additional information related to the subsidy with their Form 941 filings. However, employers claiming the credit must maintain appropriate documentation to support the credits claimed, including: (i) information (dates and amounts) reflecting AEIs’ payment of their applicable 35% of premiums; (ii) proof of timely payment of COBRA premiums to insurers for fully insured plans or proof of coverage of AEIs in self-funded plans; (iii) attestation of involuntary termination of AEI; (iv) proof of each AEI’s eligibility for COBRA and election of COBRA during the applicable period; and (v) records of the social security numbers of covered employees, the amounts of subsidies paid, and other information necessary to verify the correct credit amounts.
WHEN is the COBRA subsidy available?
The subsidy is generally available for AEI COBRA premiums for the first “period of coverage” beginning on or after February 17, 2009. For typical plans that bill COBRA premiums on a monthly basis, this will generally mean the COBRA subsidy will first apply to AEI COBRA premiums paid on and after March 1, 2009.
The retroactive coverage of AEIs involuntarily terminated on or after September 1, 2008 through February 17, 2009 means employers face two somewhat separate COBRA subsidy compliance protocols—one for AEIs terminated prior to February 17, 2009 and another for those terminated on or after February 17, 2009.
Although many AEIs involuntarily terminated prior to February 17, 2009 are currently on COBRA, others may have turned down COBRA or cancelled previous COBRA coverage due to the high cost of COBRA premiums. Employers are required to essentially provide these AEIs a “second bite at the apple” by giving them the opportunity to elect (or re-elect) COBRA coverage in light of their eligibility for the 65% COBRA subsidy.
WHAT notification obligations do employers have to AEIs?
By April 18, 2009 ( 60 days from the February 17, 2009), employers must provide all AEIs a notice explaining their “second chance” opportunity to re-elect COBRA, the availability of the 65% subsidy, and how to elect the subsidy, etc. AEIs have sixty (60) days from receipt of this notice to elect COBRA and receive the subsidy. An AEIs COBRA coverage period is not extended by this special second chance window. COBRA coverage will terminate at the same time it was originally scheduled to expire had the AEI initially elected (or continued) COBRA coverage. In most cases, the subsidized COBRA coverage will become effective retroactive back to March 1, 2009 and continue for the maximum 9-month subsidy period unless earlier terminated.
Employers will be required to provide similar notices to all AEIs involuntarily terminated on or after September 1, 2008 whose COBRA election period remains open. Employers will also need to prepare and distribute revised COBRA election forms explaining the availability of the 65% COBRA subsidy, how to elect the COBRA subsidy, and the terms regarding termination of the subsidy, etc. to all new COBRA-qualified beneficiaries through December 31, 2009.
Revised notices may be provided as separate or supplemental notices accompanying regular COBRA election forms or, alternatively, the new subsidy provisions may be incorporated in revised COBRA forms. The DOL is required to provide “model” notices for employers and their COBRA administrators to use in notifying AEIs of the new COBRA subsidy provisions by March 19, 2009 (30 days following ARRA enactment). Although the DOL has not yet released model notices or provided an estimate as to when the notices will be available, many employers, in consultation with their COBRA administrators, are electing to wait until the model DOL notices are provided before preparing and notifying AEIs of their COBRA subsidy rights in order to ensure that employers do not inadvertently exclude any DOL required provisions in their notices.
Proactive Steps for Employers:
- Employers should evaluate their current benefits arrangements to determine if they are affected by the subsidy provisions. For example, employers who have been fortunate not to have any involuntary terminations since September 1, 2008 would not appear to be subject to the changes; however, the DOL has informally advised that notices regarding the new COBRA subsidy rights should be sent to all employees terminated since September 1, 2008 and not limited just to those considered involuntarily terminated by employers. By providing notices to all terminated employees, former employees will be given an opportunity to challenge an employer’s classification of their termination as “voluntary” and thus excluded from the COBRA subsidy provisions.
- Employers that have historically paid 100% of COBRA premiums for nine or more months of COBRA coverage for all involuntarily terminated employees (and their eligible dependents) would not appear to be impacted by the changes. Again, such employers may wish to reconsider whether to continue providing full coverage in light of the availability of a 65% subsidy under ARRA.
- Employers who have not already done so should immediately contact their insurers, COBRA administrators, and payroll providers to coordinate preparation of the required notices to AEIs and to formulate a plan for ensuring compliance with the new COBRA subsidy provisions as well as the employer’s ability to track subsidy payments and claim applicable payroll tax credits to recoup the subsidy payments.
- In the interim, employers should review prior employee terminations and prepare a list of all employees terminated since September 1, 2008 along with additional information regarding whether the employees were classified as involuntarily terminated by the employer and whether they (and their eligible dependents) had coverage under the employer’s group health plan at the time of their termination.
- ARRA also provides employers the option of permitting AEIs to elect lower-cost plan or coverage options than the coverage the employee participated in at termination (e.g., an employer has the option of permitting an AEI with coverage in the company’s “buy-up” plan to elect COBRA coverage under the employer’s “base” plan). This is a change from normal COBRA rules which require employees to elect the same plan or coverage option in effect at termination. Employers with multiple plan or coverage options should carefully consider the pros and cons of permitting employees to elect lower-cost coverage options.
- As guidance on these issues evolves, employers should continue to monitor future guidance from the IRS and DOL, particularly the DOL’s development of model notices describing the COBRA subsidies, for changes or clarifications to earlier interpretations or guidance on these issues.
Since enactment of ARRA, attorneys at Smith Anderson have been advising their clients regarding its impact on COBRA and other benefits and executive compensation changes. While every effort has been made to ensure the accuracy of this alert, it is not intended to provide legal advice as individual facts and circumstances will differ and should be discussed with legal counsel. For specific technical or legal advice on the information provided and related topics, please contact Jamie Hinkle (919.821.6686) or your regular Smith Anderson relationship attorney.
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