By Ed Fensholt, JD l Mark Holloway, JD l Sara Roy, RP Health Reform Advisory Practice
- The IRS has clarified aspects of its guidance issued early in 2011, regarding the obligation of many employers to begin reporting health coverage values on employees' Forms W-2.
- The new guidance makes clear that health flexible spending accounts funded only with employee pre-tax contributions are not subject to reporting. In addition, the value of ancillary benefits such as an employee assistance program, wellness program or on-site clinic is not reported if the program is not a "health plan," or there is no COBRA premium assessed for continuation coverage under the program.
- The guidance allows the employer flexibility to report the value of some non-reportable coverage where it may be administratively convenient to do so.
- The guidance somewhat clarifies the reporting exception for employers that issued fewer than 250 Forms W-2 for the prior year.
After much anticipation the Internal Revenue Service (IRS) recently issued guidance clarifying several important aspects of the obligation on employers to reflect the value of certain health coverages on employees' Forms W-2. The new guidance clarifies reporting with respect to typical health flexible spending accounts, and with respect to employee assistance programs, wellness programs and on-site clinics. It also makes clear the circumstances where the employer, for the sake of administrative convenience, may choose to report coverages not otherwise reportable. And the guidance sheds a bit more light on the reporting exception for smaller employers.
One of the most significant administrative responsibilities employers take on this year, under 2010's federal health reform law, is the obligation to track certain health plan coverage values and then report those values on employees' Forms W-2 (the W-2s to be supplied in early 2013).
Early last year the IRS supplied initial guidance on the mechanics of the reporting obligation, but the guidance left several key questions unanswered. The Service's recent clarification is basically a re-issuance of the earlier guidance, supplemented with some clarifications and new information. Following the IRS's lead, we are here re-issuing our Alert from last April, supplemented with the additional information.
Let's Get One Thing Straight...
Before we proceed any further, let's be clear about one point. Notwithstanding hysterical Internet messages to the contrary, nothing in the health reform law makes health coverage taxable if it is now nontaxable. The W-2 reporting of health plan values is for informational purposes only. The reporting requirement appears designed to help the federal government determine the federal tax revenue it is forgoing each year with respect to non-taxable health insurance benefits supplied to employees.
Who Must Report?
The W-2 reporting obligation applies to all employers, with two main exceptions:
Indian tribal governments (and tribally chartered corporations wholly owned by federally-recognized tribal governments); and
Employers who issued fewer than 250 W-2s for the prior year.
As we note later, the value of coverage under certain benefit plans is not reported, even though the sponsoring employer may be subject to the reporting requirement.
The exception for small employers (those who issued fewer than 250 W-2s for the prior year) was vague under the earlier guidance. It was not clear, for example, whether the exception applied on a company-by-company basis, or whether the calculation was to be made on a "controlled group" basis, taking into account all W-2s issued by businesses in the same corporate family tree.
The new guidance does a better, but not perfect, job of describing the exception. The guidance says the exception is "based upon the rule in § 6011(e) that exempts employers from filing returns electronically if they file fewer than 250 returns." Section 6011(e) provides an exception, from the obligation to file tax returns or statements electronically, for "persons" who are not required to file at least 250 returns during the calendar year.
So who or what is a "person" under Section 6011? Is it the employer? Is it the controlled group of employers?
Two regulations under Section 6011 supply conflicting answers. One regulation, addressing the obligation to file Forms W-2 with the IRS electronically, excuses "persons" required to file fewer than 250 Forms W-2, and defines "person" narrowly: "[I]n the case of an affiliated group of corporations filing a consolidated return, each member of the affiliated group is a separate person." Under this definition, the calculation of whether an employer was required to file fewer than 250 W-2s for the prior year would be made on a company-by-company basis.
On the other hand, another regulation under Section 6011 says that for corporations filing income tax returns, "All members of a controlled group of corporations must file their corporate income tax returns on magnetic media if the aggregate number of returns required to be filed by the controlled group of corporations [emphasis supplied] is at least 250."
We think the better view is that the first of the two regulations is most relevant. That is, we think that in deciding whether an employer may take advantage of the W-2 health coverage value reporting exception, we look to see whether the particular employer (not the controlled group) issued fewer than 250 W-2s for the prior year. We understand an IRS official has acknowledged the lingering ambiguity on this point, and has suggested the IRS might issue an additional clarification.
One more thing: In applying the "fewer than 250 W-2s exception" for an employer that uses an agent (like a payroll vendor) to supply its W-2s, the calculation is made by looking at the W-2s the employer itself would have had to issue had it not used an agent.
What is Reported
There are three categories of benefits with which a reporting employer must be concerned. We will call these benefits Category I, Category II and Category III benefits. Only Category III benefits must be reported. Category II benefits may be reported, but the employer is not required to report them. Category I benefits are not reported under any circumstance.
Category I Benefits (Never Reported):
- Long-term care coverage;
- Certain "excepted benefits" such as accidental death and dismemberment coverage, disability insurance, liability insurance, workers' compensation coverage, and similar coverage;
- Coverage for specified illnesses (e.g., cancer insurance) or hospital indemnity coverage where the coverage is purchased on an after-tax basis or, if the employer pays the cost of the coverage, the employer's contribution is treated as taxable income to the employee;
- Employee assistance programs (EAPs), wellness programs and on-site clinics that are not "health plans" (i.e., EAPs that merely supply referrals rather than medical care, wellness programs that do not supply medical care, and on-site clinics that merely render minor first-aid to employees during working hours); and
- Dental or vision coverage either offered under a separate insurance policy or contract or, if the coverage is self-insured or offered under the same insurance contract as the medical benefits, it is offered such that participants make a separate election and pay an additional premium to obtain the dental or vision coverage.
Although as a general rule Category I benefits are never reported, there is an exception. If an employer offers a benefit program that includes both Category I benefits and reportable Category III benefits, and the Category I benefits are merely incidental in comparison to the reportable Category III benefits, the employer is permitted to report the Category I benefits. Presumably, employers would do this only if it were administratively convenient.
Category II Benefits (Reporting Permitted But Not Required):
- Health Savings Account (HSA) or Archer medical savings account contributions (note that employee pre-tax and employer HSA contributions are already reported in Box 12, under code "W");
Employee pre-tax contributions to a health flexible spending account (FSA), in most cases. Most FSAs are funded only by employee pre-tax contributions, and in these cases there is no obligation to report the FSA coverage. In some cases, where the employer provides substantial seed money to fund the health FSA, employers may have to report the cost of at least a portion of the FSA benefit;
Coverage under a Health Reimbursement Arrangement (HRA);
The cost of coverage under a multiemployer (joint trusteed, collectively bargained) plan;
The cost of coverage under a self-insured plan not subject to COBRA, such as a self-insured church plan; this exception does not apply to fully-insured coverage that is not subject to COBRA;
The cost of coverage under a governmental plan maintained primarily for the members of the military and their families;
Coverage under EAPs, wellness programs or on-site clinics where the program or clinic is a health plan (i.e., provides medical care) and the plan sponsor does not charge a premium for COBRA continuation coverage with respect to the program or clinic, or the sponsor is simply not subject to COBRA;
The cost of coverage included in income by a more than two percent shareholder-employee of a subchapter S corporation; and
Discriminatory reimbursements under a self-insured health plan that are treated as taxable income to the recipient, pursuant to Tax Code section 105(h).
Category III Benefits (Must Be Reported):
Medical plan coverage (other than medical plan coverage - such as HRA and most health FSA coverage - considered a Category I or II benefit);
Dental and vision coverage except (1) coverage that is insured and offered under a separate policy of insurance, or (2) coverage that is insured or self-insured and employees make a separate election and pay an extra amount for the coverage;
Coverage for specified illnesses (e.g., cancer insurance) or hospital indemnity coverage where the coverage is purchased on a pre-tax basis, or the employer makes a contribution toward the cost of the coverage and the employer's contribution is not treated as taxable income to the employee; and
Coverage through an employee assistance program, wellness program, or on-site medical clinic that provides medical coverage and therefore is considered a health plan, and the employer does not waive the COBRA premium for the coverage.
Notwithstanding the general rule that Category III benefits must be reported, the IRS says that if a benefit program supplies both Category III and Category I benefits, and the reportable Category III benefits are merely incidental to the program, there is no need to report on the program. We suspect the IRS is endeavoring to make clear that if a long-term care, accidental death or dismemberment or business travel accident benefit provides modest coverage for medical expenses, the employer is not required to attempt to quantify and report the value of the incidental medical coverage portion.
Calculating the 'Cost of Coverage"
Employers must report the aggregate cost of Category III benefits in Box 12 of the Form W-2, using the code "DD." This will often require determining the sum of the cost of reportable coverage under multiple plans or coverage options, some of which may be insured and some self-insured. The cost of coverage includes the employer- and employee-paid portions, whether the employee portion is paid pre- or post-tax. The fact that a portion of an employee's coverage might be taxable to him or her (e.g., employer-supplied coverage for a non-dependent child who will be age 27 or older during the taxable year) is irrelevant. Recall, however, that taxable, discriminatory reimbursements under a self-insured health care plan are not required to be reported in Box 12, because they are reported elsewhere as taxable income.
Employers may determine the cost of reportable coverage by using the COBRA rate, which probably makes the most sense for self-insured plans. If the plan is insured, the employer may use the premium charged by the insurance company. If the employer subsidizes an employee's COBRA coverage, it may include the value of the employer's subsidy in the reportable cost of coverage. The employer may use different methods for different plans.
In many cases the cost of an employee's coverage changes during a calendar year. For example, assume the plan year runs from July 1 to June 30, and effective July 1 the cost of coverage increases. Or suppose the employee changes from single to family or family to single coverage during the year. In these cases, the reportable cost of the employee's coverage must reflect these changes. Employers may use any reasonable method to comply with this requirement.
Thus, if an employee makes a coverage change during a month but the plan determines the cost of coverage on a monthly basis, the employer may choose to use the cost of coverage as of the beginning of the month, or as of the end of the month, or may prorate the cost of coverage for the month in some reasonable fashion. However, the same method must be used consistently for all employees.
Some employers set single composite premiums for coverage, or offer different coverage tiers where the cost of the tier's coverage does not change even when new dependents are added. For example, a plan might set a single composite rate that applies to every enrollee, whether or not he or she enrolls dependents. Or the plan might offer "employee only," "employee + one," and "employee + family" rates, where the employee + family rate does not change as additional dependents are added.
In reporting coverage values on the Form W-2, the employer may report values in the same manner. For example, if the plan charges a single composite rate, the employer may report that rate for every enrollee, on his or her W-2, even though it is obvious the value of the coverage supplied to a single employee is less than the coverage supplied to a family.
Similarly, if the employer offers different coverage tiers, it may report the rate for the tier in which the employee is enrolled, even though the literal coverage value for an employee enrolled with two dependents under "employee + family" will be less than an employee enrolled with five dependents under "employee + family."
An employer might use a composite rate for active employees, but not for determining the applicable COBRA premium. For example, perhaps a plan using a composite rate for all active employees, regardless of the number of dependents an employee enrolls, charges former employees a COBRA rate equal to a lesser amount, such as the plan's true cost for covering a single individual.
For W-2 reporting purposes, the employer may use either approach, provided the same method is used consistently for all active employees and the same method is used consistently for all qualifying beneficiaries receiving COBRA coverage (assuming the employer is choosing to report the value of COBRA coverage).
Obviously, the IRS is attempting to supply employers with maximum flexibility regarding the W-2 reporting obligation. However, whatever method the employer uses, the employer must be consistent in its approach.
W-2s Issued to Terminated Employees
Employees who terminate employment during the year pose a couple issues which the IRS has resolved practically. Even though such an employee may demand a Form W-2 immediately (and the employer must supply it), there is no need to report health coverage values on his or her mid-year W-2. Rather, the obligation to report health coverage values applies only to W-2s issued after the close of the year.
In addition, employers can choose whether to include on the Form W-2 at year's end only the value of coverage supplied up to the date of termination, or include the value of COBRA coverage purchased by the employee through the end of the year. But whatever method the employer adopts, it must apply it consistently.
Retirees, COBRA Beneficiaries and Others Who Don't Typically Receive a W-2
Good news. There is no requirement to report coverage values with respect to an individual to whom the employer is not otherwise required to issue a Form W-2. So with respect to retirees, spouses and dependent children purchasing COBRA, independent contractors, and other individuals who would not otherwise receive a Form W-2 from the employer, there is no need for the employer to issue them a W-2 simply to report the value of health coverage they received from the employer.
Transfers, Common Paymasters and the Form W-3
Where there are related employers with a common paymaster, an employee who receives coverage through two or more of the related employers should receive a single W-2 from the common paymaster, showing the aggregate value of all the reportable coverage supplied to him or her by the related employers. A related employer who is not acting as the common paymaster does not report the cost of coverage it provides.
However, where related employers employ the same employee and do not utilize a common paymaster, the value of reportable coverages supplied to the employee by the employers may be reported by:
One of the related employers, showing the entire aggregate reportable cost on a single Form W-2 provided to employee; or
Two or more of the related employers, on multiple W-2s issued to the employee, allocating the aggregate reportable cost among those employers (and their W-2s) using a reasonable allocation method.
Where an employee transfers to an employer that is considered a "successor" employer for FICA tax purposes, both the predecessor and successor employers report the cost of coverage that each provided to the employee during the year...unless the successor employer chooses to report the coverage values supplied by both employers. In that case the predecessor employer does not also report the value of the coverage it supplied prior to the transfer.
Employers are not required to report the aggregate value of health coverage supplied to all employees on their Form W-3 transmittals.
Third-Party Sick Pay Providers
In some cases, such as where an employee on a disability leave is receiving sick pay from a third-party sick pay vendor, that vendor will supply a Form W-2 to the employee, showing the taxable sick pay provided by the vendor on behalf of the employer. The third-party sick pay provider is not required to report on the Form W-2 the value of health coverage supplied by the employer to the employee.
If, however, the employer also furnishes a Form W-2 to the employee, the employer's W-2 must include the aggregate value of reportable Category III benefits provided by the employer to the employee.
Notice of Coverage Change After Calendar Year
Suppose that after the close of a calendar year (e.g., we'll use 2012 to illustrate the point) an employee notifies the employer that he was divorced in that prior year (2012), so that a portion of the coverage supplied by the employer to the employee in 2012 was coverage of the employee's ex-spouse? Is the employer required to modify the 2012 W-2 issued to the employee, to subtract the value of the coverage supplied to the ex-spouse?
No. The employer is not required to modify the 2012 W-2, nor is it required to issue the employee a corrected W-2 if the employer has already furnished the employee his or her 2012 W-2.
Coverage and Payroll Periods Continuing Into the Following Calendar Year
Sometimes a payroll or coverage period will span a few days in both the current taxable year (e.g., 2012) and the following taxable year (e.g., 2013). Must the employer calculate the value of the coverage supplied in the portion of the payroll period that extends into 2013, and ensure it is not reported on the 2012 W-2?
No. The IRS gives the employer some administrative flexibility here. For example, where a final 2012 payroll period continues into 2013, the employer may:
Treat all the coverage for the payroll period as provided during 2012;
Treat all the coverage for the payroll period as provided during 2013, and report it on the 2013 W-2 the employer will issue in early 2014; or
Allocate the cost of coverage for the payroll period between 2012 and 2013 under some reasonable method.
Employers need to start considering the administrative issues associated with W-2 reporting, if they have not already done so. The IRS is unlikely to further delay the W-2 reporting requirements, so employers should start sooner rather than later. IRS officials have informally indicated that the agency has the right to impose penalties if W-2s are inaccurately prepared (e.g., up to $50 per incorrect form).
Not Legal Advice: Nothing in this Alert should be construed as legal advice. Lockton may not be considered your legal counsel and communications with Lockton's Compliance Services group are not privileged under the attorney-client privilege.
Circular 230 Disclosure: To comply with regulations issued by the IRS concerning the provision of written advice regarding issues that concern or relate to federal tax liability, we are required to provide to you the following disclosure: Unless otherwise expressly reflected herein, any advice contained in this document (or any attachment to this document) that concerns federal tax issues is not written, offered or intended to be used, and cannot be used, by anyone for the purpose of avoiding federal tax penalties that may be imposed by the IRS.