Health and Welfare Changes: Small Business Job Protection Act of 1996 and Health Insurance Portability and Accountability Act

You probably remember the flurry of bill-signing President Clinton went through on returning from his Jackson Hole vacation in August: three bills in three days. Two of those bills affected health and welfare plans sponsored by employers: The Small Business Job Protection Act, though this act made more minor changes than the other one, signed the next day. The larger changes come from the Health Insurance Portability and Accountability Act or HIPAA. The changes coming under both acts are highlighted here, with suggested actions you as an employer might take.

I. Small Business Job Protection Act

A. Educational Assistance Plans. Educational Assistance Plans under Section 127 of the Code were reinstated, permitting amounts paid by an employer for tuition and fees to be excluded from an employee's income. Tax benefits for such plans had expired December 31, 1994, but the law change now accords them tax-favored status for taxable years beginning before June 1, 1997. In 1997, only expenses paid for courses beginning before July 1, 1997 are eligible for the exclusion.

Graduate-level courses, as well as courses which typically lead to a professional degree such as law or medicine, are no longer eligible for exclusion, after June 30, 1996.

Suggested Action. Employers withholding tax on tuition (due to expired provision) should stop withholding. Employers who filed W-2s including reimbursements as taxable income must issue amended W-2C forms to enable employees who paid income, FICA and Medicare tax on educational reimbursements in 1995 or 1996 to obtain a refund.

B. Death Benefits Paid by Employer Not Excludible. Death Benefits of up to $5000 paid directly by an employer are no longer excludible from income. Death benefits paid through insurance are still excludible. The income exclusion applies to benefits paid for deaths after August 20, 1996. Another life insurance change provided that "viatical settlements" paid on a life insurance contract during the life of a terminally or chronically ill individual to that individual are excludible from income tax.

C. COBRA Continuation Rules. COBRA continuation rules were modified. Those dependents of an employee who become entitled to Medicare who have a subsequent qualifying event are entitled to 36 months of COBRA coverage following the date the employee becomes entitled to Medicare. "Entitled" to Medicare means actually enrolled.

Also, disabled employees and disabled dependents needn't have been disabled for Social Security purposes on the date of the qualifying event, as long as they become disabled and eligible for Social Security benefits within the first 60 days of continuation coverage to be able to extend coverage for 29 months.

The term "Qualified Beneficiary" (i.e. someone who is able to continue coverage) now includes a child born to or placed for adoption with the covered employee during the continuation period.

Required Action. Employers are required to notify current COBRA continuees of these changes by November 1, 1996. (NOTE: A sample notice is available from Briggs and Morgan.) Employers also need to revise their general COBRA notices.

D. Employer Adoption Assistance Programs. An employee may exclude from income up to $5000 for amounts furnished under an employer's adoption assistance program if used for qualified adoption expenses for adoption by the employee of a child. This limit is per child, not per year. The exclusion is $6000 for a child with special needs. Foreign adoption (even for special needs children) costs excludible are limited to $5000. This income exclusion phases out for taxpayers with adjusted gross income over $75,000 and is not available to those whose adjusted gross income exceeds $115,000.

Adoption Assistance Plans must be in writing, must be formally adopted by an employer, must be available to employees on a nondiscriminatory basis, and are only available through the year 2001. Benefits cannot be offered through a cafeteria plan.

II. Health Insurance Portability and Accountability Act

A. Medical Savings Accounts. Medical Savings Accounts (MSAs) are a new benefit. They will be available as a savings account for employees of employers who cover them under a high deductible medical plan, providing tax benefits in three ways:

1) a deduction to employers for contributions they make to employees' MSAs,

2) an income exclusion to employees for such employer contributions and a deduction for amounts they contribute (limited to amounts above 7 1/2% of adjusted gross income), and

3) an exemption from income tax for any income earned on MSAs. A new Code Section 220 covers MSAs.

MSAs are for small employers, determined in 1997 as those with an average of 50 or fewer employees on business days during either of the two preceding calendar years, providing the employer was in existence during that preceding year. After 1997, small employers who can offer MSAs are those with 200 employees or less. After 1999 only employees who previously had MSA contributions could make new MSA contributions (or have employer contributions made on their behalf.)

The IRS will cap MSAs at 750,000 accounts. If more than 375,000 accounts are set up in 1997, the number permitted in future years will be limited.

To participate in an MSA, an employee must be covered by a "High Deductible Plan." For individual coverage the deductible must range from $1,500 to $2,250; for family coverage it must range between $3,000 to $4,500. (Where a state law requires that preventative care be provided without a deductible, that restriction does not eliminate the plan from qualification for being paired with MSAs.)

Employers may offer different health plans to different employee groups and still offer MSAs. Comparability rules will set equivalent limits.

MSA contributions are limited. For individual coverage, contributions are limited to 65% of the deductible under the high deductible plan in which the employee participates. For family coverage, contributions are limited to 75% of that deductible. The contribution can be different each month if the deductible under the plan changes or if one switches from single to family coverage, etc.

Out-of-pocket costs for participants must be limited as well. Not only is the deductible amount established, but annual out-of-pocket costs must be capped. For an individual, out-of-pocket costs must be capped at $3,000, while for families, such costs are limited to $5,500. Limits in future years will be indexed in $50 increments.

MSA income is not taxed while kept in the account. Further, distributions will not be taxed if received in a year in which the employee was covered by a high deductible plan, provided that distributions are applied to medical expenses. MSA distributions are includible in a decedent's gross estate for estate tax purposes and are eligible for the marital deduction.

MSAs receive favorable tax status effective January 1, 1997. Complex rules will govern administration of MSAs. Each individual will have his/her own account, each must be trusteed. Since each distribution is tax-free only if the employee meets specific requirements, a record-keeper will have to keep track of the MSA holder's coverage in a high deductible plan at the time of the account distribution.

B. Health Insurance Deductions. Health insurance deductions for self-employed individuals have been raised through a phased-in deduction schedule:

1997 increase from 25% to 40% 1998-2002 45% 2003 50% 2004 60% 2005 70% after 2005 80%

This deduction level will apply to sole proprietors, independent contractors, partners and subchapter S shareholders.

C. Long Term Care Benefits. Long term care ("LTC") benefits paid out of insurance policies or cafeteria plan reimbursement accounts are now deemed to be accident and health benefits under Code Section 105.
Premiums for LTC insurance are deductible, like premiums for health insurance, if above 7ÿ% of Adjusted Gross Income. There is no deduction or income exclusion if premiums are paid through a cafeteria plan. The deduction is capped based on age and is adjusted in future years for inflation. The annual limit on deductions for LTC premiums is $200 for someone at age 40.

LTC benefits paid are exempt from taxable income up to $175 per day, and higher than this limit if actual LTC costs support this higher level. Note that cafeteria plans can allow reimbursement of LTC costs for dependents since they are deemed to be accident and health benefits, even though premiums payments cannot be paid under a cafeteria plan.

Payors of LTC benefits will be required to file an information return annually, furnishing it also to the payee and including:

a. amount of benefits paid during year

b. per diem, periodic or other basis for payments

c. name, address and TIN(taxpayer identification number) of individual paid.

Penalties will be assessed for failure to file this information return.

Suggested Action. Employers should consider amending cafeteria plan medical reimbursement accounts to permit LTC benefits.

D. Portability, Access and Renewability Requirements. Portability, access and renewability requirements are new for employer-sponsored health care plans, effective for plan years beginning after June 30, 1997. New Code Sections 9801 through 9806 contain these requirements. These requirements apply to both insured and self-funded plans.
Limitations on Pre-existing Conditions:

• An exclusion may only be imposed on new participants if the exclusion relates to a condition (physical or mental) for which medical advice, diagnosis, care or treatment was recommended or received within the 6 month period ending on the enrollment date;
  
  
• The exclusion can only be applied for 12 months after the enrollment date (or 18 months on the case of a late enrollee); and

• Most importantly, the pre-existing condition exclusion period is reduced by the length of participant's enrollment under a prior group health plan. Such plans include employer sponsored group health plans, Medicare Parts A or B, benefits under Title XIX of the Social Security Act, medical care programs under the Indian Health Service, a state health benefits risk pool, a public health plan, a health benefit plan under the Peace Corps Act, among others. Coverage under a long term care plan does not count, however.

In crediting prior service, if there was a 63 day gap in coverage, coverage prior to that gap is not credited. The period ends when an individual is enrolled. Waiting periods and "affiliation periods" are excluded in counting a gap in coverage, even though benefits are not provided during that period.

Plans must provide certification of the period of "creditable coverage" when a participant's coverage or COBRA coverage ceases and upon request within 24 months of coverage ceasing. i.e. Employers must maintain coverage information for 24 months. Disclosure requirements take effect June 1, 1997.

Exceptions: Exclusions must not apply to newborns who are covered within 30 days of birth, or to adopted children covered within 30 days of adoption or placement for adoption, and for pregnancy.

Discrimination Based on Health Status is prohibited.

A plan may not set eligibility rules which deny participation to individuals and/or dependents based on:

a. Health status,

b. Medical condition (physical and mental),

c. Claims experience,

d. Receipt of health care,

e. Medical history,

f. Genetic information,

g. Evidence of insurability,

h. Disability.

A plan cannot set different contribution levels based upon any of the categories set out above. A plan can, however, uniformly increase its employee contribution level for all participants due to the cost of covering these people.

These rules apply to waiting periods as well as actual enrollment. They do NOT preclude a group health plan from limiting the benefits provided under the plan or establishing limitations on the amount, level, nature or extent of benefits or coverage for similarly situated individuals enrolled in the plan.

Penalties for noncompliance with insurability standards under Code Section 4980D.

a. Assuming a violation is "de minimis" a plan sponsor or employer may be assessed a $100 per day fine per aggrieved individual, with a $2,500 minimum per individual. The period is measured from date of failure to date of correction.

b. If a violation is not de minimis, the minimum penalty per person is $15,000.

c. Certain exceptions apply:

• Small employers (2 to 50 employees) with insured health plans are not subject to penalties.

• Tax is not imposed if failure was due to reasonable cause and not wilful neglect.

• No tax is imposed if IRS is satisfied that the responsible party did not know and, even exercising reasonable diligence, would not have known the defect existed.

• The failure is corrected within 30 days from the date the responsible person knew the failure existed. Note: therefore no tax if failure was unintentional and corrected with 30 days.

• IRS has authority to waive penalties where convinced of reasonable cause for failure.

• Church plans are exempt.

d. No enforcement action will be taken before January 1, 1998 or later, as of the date specified in regulations to be published.

Suggested Action. Employers should compare their current health plans provisions to these new requirements to see if change will be required after July 1, 1997. Employers should also set a plan in place for issuing certifications of coverage when employees terminate. Those may be may be generated and sent along with a COBRA notice. They also need to be sent when COBRA coverage ends. Employers may need to compare these requirements with those required for plans which are insured in Minnesota subject to Minnesota law.