Discriminatory Opt-Out Benefit

CEO (a highly compensated employee) and company are negotiating employment agreement.  The parties wish to provide that, if the CEO opts out of the company's medical plan, the CEO would receive additional cash compensation in the amount of the company's cost of coverage for that plan.  Assume that the individual's compensation is $200,000 plus he would receive an additional $20,000 if he opts out of coverage.  The company does not offer the opt-out/cash-out benefit to other employees.

I am fairly confident that this arrangement will fail the contributions and benefits portion of the cafeteria plan nondiscrimination tests set forth in 1.125-7 because it discriminates in favor of HCEs with respect to employer contributions for total benefits (which includes taxable benefits).

My question is what is the effect of failing the nondiscrimination tests in this circumstance.  1.125-7(m) provides that in such a case, the HCE must include in gross income "the value of the taxable benefit with the greatest value that the employee could have elected to receive."  In this case, whether the plan is discriminatory or not discriminatory, wouldn't the CEO have gross income in the amount of $220,000 either way?  That would mean that failing the nondiscrimination tests would be meaningless, wouldn't it?

I recognize that the agreement can be structured differently to give the CEO the same economic benefit as the above proposed structure but I wonder if anyone has any thoughts on the effect of this structure.  Thanks.

There may be an Affordable Care Act prohibition on "unconditional opt-outs" that may be relevant to this.  It is complicated and I can't remember chapter and verse, and it's possible that that prohibition has no application here, but you should consider it. 

An opt-out provision complicates the analysis of whether coverage is "affordable" under the ACA.  This is not an issue for the CEO here.

Off the top of my head:  I'm thinking that the value of the coverage would be taxable if he chooses the insurance because he could have received cash under an arrangement that does not meet 125 nondiscrimination rules.

Thanks for the response.  But the question arises because the CEO will NOT elect coverage under the employer's plan.  I'm trying to determine whether there is any adverse consequences to him or the company if he does so and receives additional compensation not available to other, non-highly compensated employees.

Is the Company subject to the employer mandate?  If so, you must offer coverage, which means that if he turns it down now but signs up later don't you have the problem described by Art Marrapese? 

Because of his income, the CEO will not be eligible for a tax credit or subsidy for getting coverage on the Marketplace so the company will not be subject to a penalty for not offering him coverage so that is not an issue.

My concern is whether under the current scenario (i.e., not electing coverage and receiving the extra compensation for doing so) not what will happen if he for some reason elects coverage down the road.

I assume you have a premium-only plan for employees to pay their share of the health insurance premiums on a before-tax basis.  Can you just say that CEO Jones' salary is $220,000 - rather than $200,000 - but if he elects coverage under the premium-only plan he must pay 100% of the premium (as opposed to the lower percentage paid by other employees)?

Chaz, the HCEs or Key Employees must include in taxable income the highest aggregate value of taxable benefits that could have been chosen for the year, regardless of actual elections.  So, what is the value of the highest cost benefit he could have selected, single coverage, family, etc.

Good luck.

Chaz, this isn't an ACA issue but rather (as you've identified) a technical disqualification issue under Section 125(b)(1) and potentially 125(b)(2). The medical opt-out feature is only available to an HCE. Therefore, HCEs and key employees are in constructive receipt of the highest value of available coverage, and would have to be taxed regardless of their individual health-or-cash election.