IRS Confirms That Your "Opt-Out" or "Cash-in-Lieu" Program Must be Added to Employee Contributions

On December 16th in Notice 2015-87 the IRS confirmed what we knew to be their most likely interpretation of employer "opt-out" or "cash-in-lieu" provisions: opt-out dollars must be added to an employee's contribution amount in determining compliance with PPACA's affordability standards.  Over the year's we've addressed this issue here and here.  This IRS Notice provides clarification on the issue.

Question Presented

How are employer payments that are available only if an employee declines coverage under an eligible employer-sponsored plan (opt-outs or cash-in-lieu programs) taken into account for purposes of determining whether an applicable large employer has made an offer of affordable coverage under an employer-sponsored plan?

Ruling and Short Answer

If an employer offers an employee an amount that cannot be used to pay for coverage under the employer’s health plan and is available only if the employee declines coverage under the employer’s health plan (an “opt-out” payment), the employer must add that opt-out amount to its required contribution amount for the purpose of determining whether the employer offers affordable care under PPACA. The IRS and Treasury rationalize that the employee may purchase the health plan coverage only at the price of forgoing a specified amount of cash compensation that the employee would otherwise receive – salary, in the case of a salary reduction, or other compensation, in the case of the opt-out payment.

IRS Rationale and Example

In the IRS's judgement, an opt-out payment has the effect of increasing an employee’s contribution for health coverage beyond the amount of any salary reduction contribution.  Foregoing that opt-out, concludes the IRS, compels an employer to add the cash-in-lieu amount to the employee contribution in calculating PPACA affordability.

Example: if an employer offers employees group health coverage through a § 125 cafeteria plan, requiring employees who elect self-only coverage to contribute $200 per month toward the cost of that coverage, and offers an additional $100 per month in taxable wages to each employee who declines the coverage, the offer of $100 in additional compensation has the economic effect of increasing the employee’s contribution for the coverage. 

In this case, the employee contribution for the group health plan effectively would be $300 ($200 + $100) per month, because an employee electing coverage under the health plan must forgo $100 per month in compensation in addition to the $200 per month in salary reduction.

Timing and Relief Period

Consistent with this analysis, Treasury and IRS have determined that it is generally appropriate to treat an unconditional opt-out arrangement as part of the employee contribution amount. Accordingly, Treasury and IRS intend to propose regulations reflecting this rule and requesting comments on the treatment of employer offers of opt-out payments.

Regulations generally apply only for periods after the issuance of final regulations. However, Treasury and IRS anticipate that mandatory inclusion in the employee’s required contribution of amounts offered or provided under an unconditional opt-out arrangement that is adopted after December 16, 2015 (a “non-relief-eligible opt-out arrangement”) will apply for periods after December 16, 2015.

For this purpose, an opt- out arrangement will be treated as adopted after December 16, 2015 unless:

1. the employer offered the opt-out arrangement (or a substantially similar opt-out arrangement) with respect to health coverage provided for a plan year including December 16, 2015;
2. a board, committee, or similar body or an authorized officer of the employer specifically adopted the opt-out arrangement before December 16, 2015; or
3. the employer had provided written communications to employees on or before December 16, 2015 indicating that the opt-out arrangement would be offered to employees at some time in the future.

For the period prior to the applicability date of regulations, employers are not required to increase the amount of an employee’s required contribution by the amount of an opt-out payment (other than a payment made under a non-relief-eligible opt-out arrangement) for purposes of § 6056 (Form 1095-C).  Therefore, an opt-out payment (other than a payment made under a non-relief-eligible opt-out arrangement) will not be treated as increasing an employee’s required contribution for purposes of any potential consequences under § 4980H(b).

However, until the applicability date of any further guidance (and in any event for plan years beginning before January 1, 2017), individual taxpayers may rely on the treatment of unconditional opt-out payments described herein for purposes of §§ 36B and 5000A and treat these payments as increasing the employer’s required contribution.

Commentary and Conclusion:

Under the principles set forth in this Notice, an employer may continue opt-out payments without having to include those opt-out amounts in the employee contributions so long as that employer had a published opt-out policy in place prior to December 16, 2015. However, the IRS' final regulations on this matter could eliminate this particular grace/relief period in a subsequent year once the IRS adopts final regulations. This notice does not provide that previously existing opt out policies will be “grandfathered” indefinitely. It simply states that until further regulation, this notice may be relied upon by employers.