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Guest Article

Deloitte logo

(From the September 26, 2005 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Additional Guidance on Retiree Drug Subsidy from IRS and CMS


Employers that have transferred excess pension assets to a special account to fund retiree medical benefits can receive the 28 percent retiree drug subsidy (RDS) and still comply with the IRC § 420(c)(3) minimum cost requirement, according to Revenue Ruling 2005-60. The revenue ruling holds the RDS is not taken into account in computing the applicable employer cost for purposes of the minimum cost requirement.

Additionally, the Centers for Medicare and Medicaid Services (CMS) has ruled employers receiving the RDS can allocate rebates across all retiree prescription drug plan participants, rather than basing the allocation on actual usage for purposes of determining "allowable retiree costs."

Background on Minimum Cost Requirement and the RDS

In general, IRC § 420 permits employers to transfer excess pension assets to a special account within the plan (a "401(h) account") that is used to fund retiree medical benefits. As long as the transfer is a "qualified" transfer it will not jeopardize the plan's tax-qualified status.

Additionally, qualified transfers are not included in the employer's gross income, and are not treated as a reversion for purposes of the IRC § 4980 excise tax or as a prohibited transaction for purposes of IRC § 4975.

Employers that make qualified IRC § 420 transfers must satisfy a minimum cost requirement. That is, the "applicable employer cost" for each year during the "cost maintenance period" must not be less than the higher of the applicable employer costs for each of the two years immediately preceding the year of the transfer. The applicable employer cost generally is the employer's cost per covered retiree. The cost maintenance period is the five-year period beginning with the year of the qualified transfer.

The 28 percent RDS is available to employers that provide prescription drug benefits to retirees that are actuarially equivalent to the Medicare Part D benefit. The nontaxable RDS is available with respect to retirees who are eligible for Part D, but who choose to remain in the employer's plan in lieu of enrolling in Part D. The deadline for applying for the RDS for 2006 is October 31, 2005.

Rev. Rul. 2005-60

The facts in Rev. Rul. 2005-60 involve a company that makes an IRC § 420 transfer in 2005, and applies for the RDS for 2006. The company's applicable employer cost was $3,600 for 2003, $3,800 for 2004 and $4,000 for 2005. In 2006, the employer receives the RDS in an amount equal to $600 per covered retiree. The question is whether the employer can disregard the RDS for purposes of determining the applicable employer cost for 2006. This matters because the company's applicable employer cost would be only $3,700 ($4,300 - $600) for 2006 if the RDS is taken into account, which is less than the $3,800 maintenance of cost threshold.

Fortunately, the revenue ruling concludes employers can disregard any RDS they receive for purposes of calculating the applicable employer cost.

Part D Drug Rebates Can Be Averaged Across All Drug Plan Participants

CMS will permit a retiree prescription drug plan sponsor that qualifies for the RDS to spread retiree plan drug rebates across all participants in the retiree drug plan, rather than allocating rebates based on actual usage by the retiree, according to Q & A 2775 posted on the CMS RDS website.

Under Medicare Part D an employer retiree medical plan will receive 28 percent of allowable retiree costs (ARC) for each qualifying covered retiree. But ARC must be reduced by any rebates and similar price concessions the plan receives. Recently, questions have arisen regarding how these rebates or other price adjustments should be allocated.

Q & A 2775 provides the following guidance:

A plan sponsor may elect to receive subsidy payments and submit cost data to CMS on a periodic or annual basis. If the sponsor elects a periodic basis, it must submit with its periodic cost data estimated rebates based on historical data and generally accepted actuarial principles (except as otherwise provided by CMS). The sponsor also must submit actual rebate information within 15 months after the end of the plan year as part of the reconciliation process. See 42 CFR 423.888(b)(2) and 423.888(b)(4). If the sponsor elects payment on an annual basis, it only has to submit cost data and actual rebate information within 15 months after the end of the plan year. Since the ARC must be determined at the individual retiree level, the rebate amounts must be allocated at the individual retiree level. While rebates must be allocated to each individual retiree's costs, plan sponsors are not required to allocate the rebates based on the individual retiree's actual usage of the specific Part D drugs for which the sponsor received rebates. Plan sponsors may choose instead to allocate rebates using a methodology that determines rebates received under the plan as a percentage of incurred drug costs, and applies that percentage to the gross retiree costs (defined in 42 CFR 423.882) of each qualifying covered retiree between the cost threshold and the cost limit. The resulting amount reduces the gross retiree cost to derive the ARC for each individual retiree. Thus, for example, if a sponsor incurred $1 million in drug costs in a plan year and received $30,000 in rebates for the same plan year, the rebate amount is 3% of drug costs ($30,000/$1 million). The sponsor then applies a 3% reduction in the gross retiree costs between the cost threshold and cost limit of each qualifying covered retiree to determine the ARC for each retiree.

See www.rds.cms.hhs.gov under "FAQ."


Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Diane McGowan 202.220.2077, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Carlisle Toppin 202.220.2067, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2005, Deloitte.


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