Group Health Insurance Coverage Cost Reporting to Employees

The following article is the last article of a four part series discussing the group health insurance coverage cost reporting to employees guidance contained in IRS Notice 2011-28 with the addition of IRS Notice 2012-9's clarifications, modifications and additional guidance.  The combined IRS notices contain 38 questions and answers (Q&A) in total.

Part I found in our January 2012 newsletter, covered the Background of the IRS Notices; the General Requirements; the Employers Subject to Reporting Requirements; and the Method of Reporting on the Form W-2.  Part II found in our February 2012 newsletter covered the Aggregate Cost of Applicable Employer-Sponsored Coverage and the Cost of Coverage Required to be Included in the Aggregate Reportable cost.  Part III found in our March 2012 newsletter covered the Methods of Calculating Cost of Coverage and Other Issues Relating to Calculating the Cost of Coverage.

This part, Part IV, covers the Additional Guidance added by IRS Notice 2012-9.

Part IV

Employee Assistance Program (EAP)

Coverage provided under an EAP, wellness program, or on-site medical clinic is only includible in the aggregate reportable cost to the extent that he coverage is provided under a program that is a group health plan for purposes of Code §5000(b)(1).  An employer is not required to include the cost of coverage provided under an EAP, wellness program or on-site medical clinic that otherwise would be required to be included in the aggregate reportable  cost reported on Form W-2 because it constitutes applicable employer-sponsored coverage, if that employer does not charge a premium with respect to that type of coverage provided to a beneficiary qualifying for coverage in accordance with any applicable federal continuation coverage requirements.  If premiums are charged employers would need to include the costs of that type of coverage provided.  An employer that is not subject to any federal continuation coverage requirements is not required to include the cost of coverage provided under the EAP, wellness program, or on-site medical clinic.  For this purpose, federal continuation coverage requirements include COBRA requirements under the Code, the Employee Retirement Income Security Act of 1974, or the Public Health Service Act and the temporary continuation coverage requirement under the Federal Employees Health Benefits Program. (Q&A 32)

Costs Included but are not Required under Applicable Interim Relief

An employer may include in the aggregate reportable cost the cost of coverage that is not required to be included in the aggregate reportable cost under applicable interim relief, such as the cost of coverage under a Health Reimbursement Account (HRA), a multi-employer plan, an EAP, wellness program, or on-site medical clinic, provided that the calculation of the cost of coverage otherwise meets the calculation requirements. (Q&A 33)

Portioning Cost using Reasonable Allocation Method

When an employee receives benefits that constitute applicable employer-sponsored coverage and other benefits that do not, such as long term care, an employer may use any reasonable allocation method to determine the cost of the portion of the program providing applicable employer-sponsored coverage. 

If the portion of the program providing a benefit that is applicable employer-sponsored coverage is only incidental in comparison to the portion of the program providing other benefits, the employer is not required to include either portion of the cost in the aggregate reportable cost.  Similarly, if the portion of the program providing a benefit that is not applicable employer-sponsored coverage is only incidental to the portion of the program providing a benefit that is applicable employer-sponsored coverage, the employer may, at its option, include the benefit that is not applicable employer-sponsored coverage in determining the reportable cost, notwithstanding the prohibition in 33 above. (Q&A 34)

Adjustments to Form W-2, When Not Required

An aggregate reportable cost reported on Form W-2 for a calendar year does not need to be adjusted for any election for notifications in a subsequent year that may have an effect on the cost of coverage in the earlier year, such as a divorce in the earlier year since the reporting is based on the information available to the employer as of December 31 of the calendar year.  In addition, an employer does not need to file a W-2c if a Form W-2 has already been provided for a calendar year, before this type of election or notification (for example, a Form W-2 is provided on January 15, and the election or notification is provided on January 20). (Q&A 35)

Calculating Cost When the Payroll Period Extends into Following Pay Year

If the payroll period extends into the following pay year, there are three methods to include coverage that includes December 31 but continues into the subsequent calendar year: (1) treat the coverage as provided during the calendar year that includes December 31; (2) treat the coverage as provided during the calendar year immediately subsequent to the calendar year that includes December 31; or (3) allocate the cost of coverage for the coverage period between each of the two calendar years under any reasonable allocation method, which generally should relate to the number of days in the period of coverage that fall within each of the two calendar years.  Whichever method the employer uses must be applied consistently to all employees. (Q&A 36)

Hospital Indemnity or Other Fixed Indemnity Insurance

An employer is required to include in the aggregate reportable cost reported on Form W-2 the cost of coverage provided under hospital indemnity or other fixed indemnity insurance, or the cost of coverage only for a specified disease or illness, if the employer makes any contribution to the cost of coverage that is excludable under Code §106 or if the employee purchases the policy on a pre-tax basis under a Code §125 cafeteria plan. (Q&A 37)

Independent, Non-Coordinated Benefits

An employer is not required to include in the aggregate reportable cost reported on Form W-2 the cost of coverage provided under hospital indemnity or other fixed indemnity insurance, or the cost of coverage only for a specified disease or illness, if those benefits are offered as independent, non-coordinated benefits and if the payment for those benefits is includable in the employee's gross income (or, in the case of a self-employed individual, the payment is one for which a deduction under Code §162(I) is allowable.  Therefore, to the extent the employer merely provides the opportunity for employees to purchase an independent, non-coordinated fixed indemnity policy and the employee pays the full amount of the premium with after-tax dollars, the cost of coverage provided under the policy is not required to be reported on Form W-2. (Q&A 38)

Third Party Sick Pay Providers

Third Party sick pay providers are not required to include aggregate reportable costs on the Forms W-2 they supply to employees to report sick pay. (Q&A 39)

For your information, there are Flexible Spending Account cost examples in IRS Notice 2012-9's Q&A 19.

The Fix Is In: Common Plan Mistakes

Periodically the Internal Revenue Service (IRS) publishes an article that it calls "The Fix Is In: Common Plan Mistakes" that present common mistakes that happen in retirement plans.  These articles describe a common problem, how it happened, how to fix it and how to lessen the probability of the problem happening again.  From time to time, we will be reproducing some of those articles that we believe would be helpful to you in the day-to-day administration of your plan.

Not Correcting ADP/ACP Mistakes Timely

The Issue

Many of you have 401(k) retirement plans that provide for elective contributions. If you do, you may be familiar with the Actual Deferral Percentage test (ADP) and the Actual Contribution Percentage test (ACP). These tests provide a limit on the amount that certain benefits provided under the plan to highly compensated employees (HCEs) may exceed the benefits provided to non-highly compensated employees (NHCEs).

Under the ADP test, the average salary deferrals of the HCEs and NHCEs are calculated and compared on an annual basis based on the plan year. Each employee's deferral percentage is the percentage of compensation that has been deferred, pre-tax, to the 401(k) plan. The deferral percentages of the HCEs and NHCEs are then averaged to determine the ADP of each group. To pass the test, the ADP of the HCE group may not exceed the ADP for the NHCE group by 1.25 percent or 2 percentage points.

Similar to the ADP test, the ACP test applies to matching contributions and/or employee after-tax contributions. The plan satisfies the nondiscrimination requirements of the law if it passes the ADP and ACP tests.

If the plan fails the ADP and/or ACP tests, corrective action must be taken to protect the qualified status of the arrangement. The law and related regulations provide various methods for correcting mistakes during a "correction period." This statutory correction period is the 12-month period following the close of the plan year in which the mistake occurs. If corrective distributions are made after the first 2 ½ months of the correction period, the employer (not the HCE) is liable for an excise tax. If correction is not made within the correction period, the plan is considered "disqualified."

The Problem

One of the most common mistakes submitted for correction under the Voluntary Correction Program (VCP) is the failure to timely test for and correct ADP or ACP mistakes. Common reasons for this mistake are:

1.      Incorrectly classifying employees as HCE or NHCE;

2.      Using an incorrect definition of compensation in the tests; and

3.      Calculating the test incorrectly.

The Fix

Employers may get relief from treatment of the 401(k) plans as nonqualified through the Employee Plans Compliance Resolution System (EPCRS) by correcting the mistakes after the statutory correction period has passed. The Self-Correction Program (SCP) or Voluntary Correction Program (VCP) can be used to correct the mistakes. In order to fix the mistake under SCP, generally the mistake must be fixed within two years after the end of the statutory correction period (i.e., the 12-month period following the close of the plan year). Unless the failure can be classified as insignificant, VCP must be used after this time.

Example:        A calendar year plan with a 401(k) arrangement fails the ADP test for the plan year ending 12/31/04. The statutory correction period is the 12-month period from 01/01/05 to 12/31/05. The self-correction period under SCP runs from 01/01/06 to 12/31/07. After this date (unless the violation is considered insignificant), VCP must be used to correct the violation.

Note that there is more than one way to correct ADP and ACP mistakes under EPCRS. Generally, if SCP or VCP is used to correct a violation of the ADP/ACP test after the statutory 12-month correction period, the employer is required to make Qualified Non-Elective contributions (QNECs) for the NHCEs. QNECs are contributions made by the employer that are 100% vested, have the same distribution rules as 401(k) deferrals and do not discriminate in favor of HCEs. Under one corrective approach, the employer contributes enough QNECs to all the NHCEs in order to raise the ADP of the NHCEs to a level necessary that satisfies the ADP test. Another approach under EPCRS permits correction solely by making distributions to the HCEs after the statutory correction period as long as the employer is willing to make a contribution for the NHCEs that equals the total amount being distributed.

Making Sure It Doesn't Happen Again

Completing the ADP/ACP nondiscrimination tests accurately and timely is vital for employers maintaining 401(k) plans. The plan document, employee data, etc., should be carefully reviewed to ensure that employees are correctly classified, the proper definition of compensation is used and proper testing/correction methods are used. Plans with matching contributions and/or employee after-tax contributions can be structured so that the employer can adjust the contribution rates of the HCEs in order to prevent the plan from failing the ACP test. Similarly, some plans are designed with a discretionary matching contribution formula, where the employer can declare a different rate of matching contribution for the HCEs.

However, keep in mind, that despite all your good efforts, mistakes can happen. In that case, the IRS can help you correct the problem and retain the benefits of your 401(k) retirement plan.

Page Last Reviewed or Updated by the IRS: April 23, 2012