Another Cafeteria Plan Nondiscrimination Test Conundrum

A small employer offers only fully insured medical insurance to its employees and employees pay their share of the cost of coverage through a cafeteria plan.  One (and only one) highly compensated employee is provided with additional cash compensation for opting out of the medical coverage.

Does this violate the benefits portion of the cafeteria plan nondiscrimination tests?  If so, what is the consequence to the one HCE? 

Thanks. 

Is the opt-out credit offered to all employees who waive (and the others just declined by enrolling in the health plan instead)?  Or is the opt-out credit offered to only this one HCE to waive?

If it's the former, it's probably fine.  If it's the latter, it probably violates the uniform election rule.

Does the employee get incremental compensation because she opted out of health coverage?

To the extent the employee has a choice between health coverage and an increment of money wages, isn’t that a choice that must be properly made under a § 125 plan? Else, the employee has constructive receipt of the more valuable benefit she could have chosen.

If an incremental choice between an increment of money wages and health coverage is available to less than all health-eligible employees, does that incremental plan meet § 125 nondiscrimination?

If an opt-out amount might be added to what would be the employee’s portion of the health insurance premium, does that cause the employer’s offer of health coverage to be not affordable for one or more Affordable Care Act purposes (and related income tax and excise tax consequences)?

Does an opt-out offer violate HIPAA nondiscrimination?

Does an opt-out offer violate Medicare secondary-payer provisions?

Beyond those and other questions:

Is the employer’s opt-out offer a breach of the group health insurance contract? Or does the offer make false the application for the group health insurance contract. What are the legal consequences of such a breach or false inducement? If a false statement to the insurer is not corrected, is that a Federal crime, a State crime, or both?

This is not advice to anyone.

The opt-out compensation is only offered to the one HCE.  And, yes, the HCE gets the amount solely because the HCE opted out and the payment is contingent on opting out.

Peter's other questions are all good ones but I am just looking for the consequences to the HCE under the cafeteria plan rules for participating in this arrangement.

I can imagine at least two ways the IRS might unravel the opt-out offer:

If the opt-out offer is not expressed in a written plan, it can’t be a cafeteria plan. I.R.C. § 125(d)(1).

If the opt-out offer is expressed in a written plan but offered only to one offeree who is highly-compensated, how would that plan “not discriminate in favor of highly compensated participants”? I.R.C. § 125(c).

If the opt-out offer is no cafeteria plan at all or is a plan that discriminates, the highly-compensated offeree gets no § 125(a) exclusion for whatever results from having a choice between money wages and health coverage.

The employer might want an IRS-recognized practitioner’s advice about reporting wages for Federal income tax and for Social Security and Medicare taxes.

The individual might want advice to help her file an accurate tax return.

For questions about professional conduct, one might look to a BenefitsLink discussion in which Chaz gave us an intriguing thought. https://benefitslink.com/boards/topic/73510-health-fsa-and-hsa-how-does-irs-know/#comment-344822

This is not advice to anyone.

It's likely a violation of the Section 125 cafeteria plan nondiscrimination rules (particularly the "uniform election" component of the contributions and benefits test) that could result in the loss of the safe harbor from constructive receipt for HCPs if discovered by the IRS.  In this case, that would generally mean the HCPs would have taxable income in the amount of the available opt-out credit regardless of whether they received it.  They might also lose the pre-tax treatment overall for all cafeteria plan contributions by having the amount of the available taxable cash (i.e., regular wages/salary) included in taxable income even if they elected the health plan.

More details:

https://www.newfront.com/blog/designing-health-plans-with-different-strategies

Prop. Treas. Reg. §1.125-7:

(2) Benefit availability and benefit election. A cafeteria plan does not discriminate with respect to contributions and benefits if either qualified benefits and total benefits, or employer contributions allocable to statutory nontaxable benefits and employer contributions allocable to total benefits, do not discriminate in favor of highly compensated participants. A cafeteria plan must satisfy this paragraph (c) with respect to both benefit availability and benefit utilization. Thus, a plan must give each similarly situated participant a uniform opportunity to elect qualified benefits, and the actual election of qualified benefits through the plan must not be disproportionate by highly compensated participants (while other participants elect permitted taxable benefits)…A plan must also give each similarly situated participant a uniform election with respect to employer contributions, and the actual election with respect to employer contributions for qualified benefits through the plan must not be disproportionate by highly compensated participants (while other participants elect to receive employer contributions as permitted taxable benefits).

...

(2) Similarly situated. In determining which participants are similarly situated, reasonable differences in plan benefits may be taken into account (for example, variations in plan benefits offered to employees working in different geographical locations or to employees with family coverage versus employee-only coverage).

...

(2) Discriminatory cafeteria plan. A highly compensated participant or key employee participating in a discriminatory cafeteria plan must include in gross income (in the participant’s taxable year within which ends the plan year with respect to which an election was or could have been made) the value of the taxable benefit with the greatest value that the employee could have elected to receive, even if the employee elects to receive only the nontaxable.

Slide summary:

Newfront Office Hours Webinar: Section 125 Cafeteria Plans

I've run into the same situation a few times. In each case, it's been the incoming executive director of a smallish non-profit, but maybe that's just me.

I typically recommend they (1) increase the executive's base salary by the premium amount the employer otherwise would have subsidized, (2) uncouple it from the lack of health plan participation, (3) offer the executive the employer's health insurance on the same terms as other employees, and (4) know that the executive can, but likely will not, enroll in the health plan if she chooses on the same terms as all other employees.   

Not a huge sample size, but it's never become a problem in my experience. (I realize it could, but there also could be other ways to solve that indirectly in the future.)

I'll grant you that the arrangement does likely violate the cafeteria plan nondiscrimination tests.  What I am struggling with is the consequences to the HCE.

The arrangement just applies to ONE HCE; all other employees including other HCEs can opt of medical coverage but are not eligible to receive the opt-out payment.  Medical insurance is the only benefit offered that participants pay a portion of the premium.  The opt out arrangement for the one HCE is reduced to writing, which is included as part of the cafeteria plan and is specific enough to be clear that the other HCEs are ineligible for it. 

A simplified example with round numbers:

HCE earns $100,000 per year.  Participants' share of the cost of coverage equals $10,000 per year.  The opt out payment is $15,000.  So, if the HCE participated in the health plan, the HCE's taxable income would be $90,000 but because the HCE opted out, the HCEs taxable income is $115,000 (whereas other HCEs who opted out would have taxable income of $100,000).

What would the tax consequences be to our lucky HCE friend in this scenario?  It seems to me that the HCE is already being taxed on the value of the highest benefit he could receive.

(The actual situation I am facing is somewhat similar to what EBECatty runs in to periodically.  I have suggested virtually exactly the same design to the client as EBECatty suggests but the client is resisting.)

Thanks!

Yeah if there's only one HCP involved I think you're right.  Still wouldn't want that structure in place in case another HCP comes along who wants to enroll in the plan someday, but until then I think there's no practical consequence of the discriminatory arrangement.  As you noted, that HCP is already being taxed on the full amount anyway via the cash opt-out credit.

Chaz, might an element be missing from your simplified example? What is the fair-market value of the health coverage?

Using your example, let’s put an illustrative amount on the value of the health coverage: Imagine $30,000.

An employee who’s not offered an extra opt-out payment chooses health coverage, has $10,000 taken from her pay, and gets another $20,000 in value provided by the employer. (Assume this layer of choice is a proper § 125 plan, and does not discriminate.) Her Federal income tax wages is $90,000. (Her total compensation is $120,000.)

The employee who is offered an extra opt-out chooses against health coverage, has $0 taken from her pay, and gets the $15,000 opt-out payment. If what I’ll describe as the “second” § 125 plan (the choice offered only to the one specified individual) discriminates, the offeree, if highly-compensated, is not relieved of constructive receipt of whatever she could have chosen. Looking to the greater-of, the $20,000 value of employer-provided health coverage counts in her gross income; it is $120,000, not $115,000.

Might an employer’s or employee’s tax practitioner analyze it this way?

If § 125 does not apply to the extra opt-out choice, must an employer recognize constructive receipt in its Form W-2 wage reporting?