Rev. Rul. 2002-27 - request for debate

[Guest slt]

QUESTION ONE

Rev. Rul. 2002-27 is troubling to me on so many levels. First of all, this was slipped in to the "list of amendments to be made by the end of the year" after many people had already amended their plans for EGTRRA (any changes under this Rul. that you make are tagged to the EGTRRA period).

Second, I don't think this was a big problem until the IRS made it a problem with issuing this Rev. Rul. I think most plans just assumed the amounts used to pay for coverage in Scenario 2 of the Rev. Rul. were pre-tax and 125 amounts and lumped them into the 415©(3) definition. Now the IRS says that these amounts are not supposed to count in the definition and therefore these people have less of a testing base for 415 purposes (i.e., 415© is tagged to a dollar amount or 100% of compensation. Assume someone in Scenario 2 of the Rev. Rul. making $15,000 pays $1,000 for coverage - his or her 415© comp is now $14,000) versus someone else in Scenario 2 who has $15,000 in 415© comp because he has alternate coverage and elects it). What I don't understand is why the IRS thought this was a problem? First of all, I would think that single people are heaviest hit since they do not have a spouse who has alternate coverage under which they could apply. Generally, single people tend to make less than a married couple. So the effect of this Rev. Rul. is to penalize/hurt people who make less money. Aren't the 401(a)(4) rules designed to protect NON-highly compensated individuals? What gives? This makes NO sense to me.

Another hard hit group of people are those with domestic partners. Unfortunately, numerous employers do not offer health care coverage to domestic partners (straight or gay) of employees. (If you are in a state like VA, it may even be ILLEGAL to offer benefits to same-sex partners). This means that the other DP will most likely find himself in a Scenario 2 situation. Generally, electing family coverage over the default coverage would put you back in 125 and all would be well, but many domestic partner couplings (especially male-male) do not have children - or may be barred by state law from adopting, etc. So, once again, we have a group of people unfairly targeted by this Rev. Ruling.

ANOTHER problem is what do I do with qualified medical child support orders? If my plan gets a court order that says that I MUST OFFER COVERAGE to my child, then I really don't have much of an "election", do I? In fact, it's the same scenario as if I were forced to take a default type of coverage. Are amounts used to pay for my child's health care under the order NOW not considered 125 amounts? Under this Rev. Rul. - I would think the answer is yes.

Can others think of other scenarios that might come under Rev. Rul. 2002-27?

Basically, I can't see any real justification for this Rev. Ruling and I would like to know what others think. Thanks so much for commenting!

QUESTION TWO

Another question I have concerning this Rev. Rul. is why the IRS says that you can treat amounts paid for coverage under scenario 2 where the employee has no other coverage as "deemed 125" contributions IF AND ONLY IF you do not otherwise request or collect information regarding the employee's other health coverage as part of the enrollment process for the health plan.

My thoughts are that the IRS thinks that where you simply have the employee certify that he has coverage, well, the reality is that someone can LIE and check that he does have coverage (when he really does not). Then, that employee would opt out and get money! So, in theory, he has the ABILITY TO CHOOSE BETWEEN money and coverage. On the other hand, if you request or collect information regarding other health coverage, well, you have the ability to VERIFY that the person indeed DOES have coverage. So there is no way around it - there is no ability to choose between money and coverage if someone really doesn't have coverage. That is the ONLY policy I see, and I'm not sure I like it. Does anyone agree? If not, why do you think the caveat was made?

Thanks again.

[E as in ERISA]

I didn't think that these arrangements were common (where employers forced employees into a health plan when they couldn't prove they had other coverage). I don't think it will affect many.

It was technically incorrect for an employer to treat these premiums as pretax when there was no choice between cash and the health insurance. So employers would have been forced to treat those who are making the choice (because they have other coverage) different than those who are not making the choice (because they don't have other coverage). As you note, any employer that did have this type of plan would probably have overlooked the difference and would have erroneously treated these as 125 dollars, which would have created qualifications issues for their plan (because testing compensation would have been wrong). This ruling simply allows the monies to be treated as pre-tax without risking disqualification.

Employees do not have to be disadvantaged by this ruling -- because 415©(3) compensation does not have to be used for allocation purposes. The "deemed 125 contributions" can be added back for purposes of the definition of compensation used for allocations.

The recent Rev. Proc. allows extends the period for making this amendment.

[Guest slt]

Katherine, thank you for your response. I have a few clients that have been affected, but I do agree that it is not a large number of plans that are affected.

One thing - I think Rev. Proc. 2002-73 only extends the period to amend for this change for pre-approved plans. You'll notice that it extends the period to the later of the time period under the ruling (EGTRRA good faith deadline - which is Dece. 31, 2002 for calendar plans) or the end of the plan's GUST remedial amendment period. See Section 4.02. For most plans, the GUST remedial amendment period is over. So we are stuck with the original deadline inthe Rev. Proc.

2002-73 is really not that helpful for plans other than pre-approved plans unless you needed an extension to comply with CRA (remember that this is only until June 30 - not September - 2003).

[Guest Milton Wright]

It may not affect many people in most of the country, but in Hawaii, the ruling affects every employer with a cafeteria plan. Under the state Prepaid Healthcare Act, an employer may not allow an employee to opt out of employer-provided coverage unless the employee certifies that he or she has other coverage. Moreover, the state-mandated certification form requires the employer to collect information about the other coverage in some circumstances. Our response has been to modify the model amendment to permit compliance with the state law. I'm not very comfortable with this approach, but we can't follow the model amendment without violating state law, and trying to apply the IRS's hyper-technical reading of the compensation definition is administratively somewhere between difficult and impossible for a lot of employers.

We're at a bit of a loss and hoping that the IRS may re-think this one a little bit.

By the way, I was told that the reason for the prohibition on collecting information about other coverage was to deter fraud. Apparently the IRS was afraid that if the employer had information about the employee's other coverage, the employer would be tempted to accept a fraudulent certification. Maybe I'm missing something, but it's not clear to me how it improves the situation for the IRS to make sure that the employer is ignorant of any fraud the employee is committing.

[Guest slt]

Milton, I had no idea about the HI problem, but what a mess!!!!

Another problem I see with this Rev. Rul. is what happens if you have a Scenario 2 situation and you have one employee (Employee 1) who has no other coverage and must receive coverage under the plan and one employee who has other coverage (Employee 2) but WHO still chooses coverage under the plan ((i.e., by not "opting out") because the other coverage is not as good (e.g., spouse works for the federal government whose health plan is not that great)? Under the Rev. Proc., Employee 1's payments are not 125 payments because he has to take the default coverage. However, Employee 2's payments ARE 125 payments because he had a bona fide choice.

Notice the impracticality of this ruling. How is the Plan Administrator supposed to know that Employee 1 does not have 125 protection while Employee 2 does? Note that according to what you say, Katherine (with whom I completely agree), the IRS could disqualify your entire plan if you added Employee 1's payments into the 415©(3) definition of compensation. Are all plan administrators supposed to now put in a box that employees can check off that states " I have other coverage but I am still electing coverage under this plan?" Wouldn't we then need a certification or proof of this? If the IRS's goal was to prevent fraud, then it has failed because it has just created a situation where it behooves Employee 1 to check off the "I have other coverage" box just to get the 125 protection.

Not surprisingly, the IRS offers no solution to this problem. So, yet again we have another IRS ruling that creates more problems than it was "intended" to solve (as if there were really a "problem" in the first place).

[Guest slt]

Milton,

Thanks again for your reply. I am currently attempting to navigate the channels to appeal this Rev. Proc. and think that I will have some success. To the extent you can easily get your hands on it, would you happen to have a cite to the Prepaid Healthcare Act as well as support (or a copy of a model form or cite) for the position that "the state-mandated certification form requires the employer to collect information about the other coverage in some circumstances"? Thanks so much!

-slt

[Guest Milton Wright]

The Prepaid Healthcare Act is chapter 393 of the Hawaii Revised Statutes. I've never managed to locate an on-line version of the state form, but it's Form HC-5 issued by the Disability Compensation Division of the state Department of Labor. The portion of the form to which I was referring applies primarily (I believe) to employees who are potentially eligible for coverage from two employers (i.e., who work more than 20 hours per week in each of two jobs). The relevant language is "I waive coverage from my employer's health care plan; in lieu I have obtained a plan from __________________ (name of health care plan contractor) which meets the Hawaii Prepaid Health Care Law (attach copy of plan and send to the DC Division)."

I'd be happy to provide additional background, cites, links, etc. back-channel if it would be helpful to you. My e-mail address is mwb1861@hotmail.com.

Good luck! I appreciate your efforts and hope they'll be successful.

[Steve72]

Link to Chapter 393 of Hawaii Revised Statutes:

http://www.capitol.hawaii.gov/hrscurrent/V...6-0398/HRS0393/