Health coverage post-employment

[Guest JMN]

If an employer pays a former key employee for the entire cost of health coverage under its self-funded ghp, is that taxable compensation to the employee that is potentially 409A income if such coverage is not available to non-key employees?

If so, how to comply wtih 409A? Simply include the factors in 1.409A-3(i)(1)(iv)?

[Guest Salvador A Mander]

If an employer pays a former key employee for the entire cost of health coverage under its self-funded ghp, is that taxable compensation to the employee that is potentially 409A income if such coverage is not available to non-key employees?

If so, how to comply wtih 409A? Simply include the factors in 1.409A-3(i)(1)(iv)?

It is likely taxable and therefore potentially subject to 409A. If it's a separation pay plan, it is not deferred compensation if limited to the COBRA period.

[Chaz]

Non-409A comment: The arrangement you describe likely violates the Code Section 105(h) nondiscrimination rules if the amounts paid are not taxable to the employee.

[Guest Salvador A Mander]

Chaz, I think it's the 105(h) nondiscrimination that would make it taxable and therefore potentially deferred compensation. IF it is nondiscrimatory (and therefore taxable), and the coverage extends beyond the COBRA period, then the cost of coverage is deferred compensation.

If anyone disagrees, please correct me.

[Chaz]

Chaz, I think it's the 105(h) nondiscrimination that would make it taxable and therefore potentially deferred compensation. IF it is nondiscrimatory (and therefore taxable), and the coverage extends beyond the COBRA period, then the cost of coverage is deferred compensation.

If anyone disagrees, please correct me.

Just a quick clarification: If the amounts are not taxable, the arrangement will likely fail the nondiscrimination tests, not the other way around. The consequences for failing the nondiscrimination tests are not necessarily that the amounts paid become taxable.

I can't opine on the 409A part of the question.

[401 Chaos]

Seems like too that whether or not the amounts cause a 409A issue depend on whether or not the company actually treats the reimbursements as taxable income to the former executive or treats it as nontaxable income. In the self-funded context, 105(h) does not necessarily prevent you from having discriminatory benefits, it just imposes potentially large adverse taxes on the recipient because it makes the value of the benefits received (i.e., the actual medical bills paid on behalf of the recipient) taxable income as opposed to simply taxing the "premiums" paid by the employer on behalf of the former employee. I suppose if the recipient actually paid taxes on those amounts though there would be no real deferral of income and thus no 409A issue. The problem comes in when nobody handles the 105(h) amounts properly. For these reasons, we generally try to structure these sorts of continuation benefits differently--i.e., as taxable reimbursements for ex employee's payment of COBRA premiums under the plan (could be grossed up if necessary) or even paid out as a lump sum taxable cash amount to cover health insurance costs for some severance period (again could be grossed up if parties agree). One common approach used to be for the company to simply arrange for individual policy coverage for the ex executive and pay for that rather than under the group health plan (assuming no insurability issues) but the new 105(h) nondiscrimination provisions to be extended to fully insured benefits means that approach may have limited shelf life at this time. Unfortunately, I think this is a complex area that is often abused or glossed in severance / employment agreements and the lack of enforcement around 105(h) generally means that folks have and continue to do things in ways that likely would cause significant violations if the rules were enforced.