Final Rules Fix Family Glitch

Seyfarth Synopsis: Recently, on October 11, 2022, the Internal Revenue Service (IRS) issued final regulations which finalized changes to affordability of employer coverage for the family members of employees under Internal Revenue Code (Code) §36B. While these final regulations are seen as “family-friendly” (in their expansion of the availability of the premium tax credit), they likely will have little impact on employers. On the same date, the IRS issued Notice 2022-41, which provides for additional permitted election changes for group health plan coverage under cafeteria plans to correspond with changes made by the regulations.

The Final Regulations

The final regulations (available here) implement aspects of the IRS’s proposed regulations from earlier this year. Some notable highlights, which are effective for tax years beginning after December 31, 2022, are:

• Affordability and Employer Mandate: Under the Affordable Care Act (ACA), individuals who are offered affordable, minimum value health coverage through an employer are not eligible for a premium tax credit (PTC). Under regulations issued in 2013, affordability for an employee and the employee’s family was based on the cost of self-only coverage. Thus, if the cost of self-only coverage was more than 9.5% (adjusted annually) of the employee’s household income, no PTC was allowed for family members even if family coverage cost more than 9.5 percent of household income. The final regulations fix this so-called “family glitch” by providing that coverage under an employer-sponsored plan is affordable for an employee’s family members if the cost of family coverage does not exceed 9.5% of household income. Importantly, even though affordability for the family members will be based on the cost of family coverage, affordability for the employee is unchanged and remains based on the cost of self-only coverage. Thus, the final regulations will not directly impact the liability of a large employer under the employer mandate because they do not affect an employee’s eligibility for an exchange subsidy.
• Reporting and Safe Harbors: The final regulations do not change the information reporting requirements for employers. This includes IRS Forms 1094-C, 1095-C, 1094-B, and 1095-B. Additionally, the IRS notes that the safe harbors an employer may use to determine affordability under the employer mandate regulations continue to be available to employers. These include the federal poverty line safe harbor, the rate of pay safe harbor, and the W-2 safe harbor.
• Impact on Employer Premiums: In the final regulations, the IRS notes that they expect the final regulations to have a minor impact on employer premiums because only a small number of individuals are expected to move to the exchange. Additionally, the departments speculate that the aggregate amount that employers spend on family coverage may even decrease by a small amount because some individuals who would otherwise enroll in employer coverage will prefer to enroll in Exchange coverage given a premium tax credit. Overall, the net effect on employer premiums is expected to be negligible, if any.

IRS Notice 2022-41

In conjunction with the regulations discussed above, the IRS also issued Notice 2022-41 (the “notice”) to provide some flexibility to cafeteria plan sponsors to amend their plans to permit participants and their covered family members who enroll in a Qualified Health Plan (QHP) through the Health Insurance Exchange (Exchange)—either during the Exchange’s annual open enrollment period or during a special enrollment period for Exchange coverage—to prospectively drop some or all such family members from the sponsor’s group health plan coverage based on their enrollment or intended enrollment in Exchange coverage. The notice applies to elections effective on and after January 1, 2023.

Like Notice 2014-55 before it, which expanded on the election change events permitted by Code § 125 cafeteria plan regulations (in 26 C.F.R. § 1.125-4) to allow cafeteria plan sponsors to adopt amendments permitting employees to prospectively revoke their own group health plan coverage due either to a reduction in hours of service (and enrollment in other minimum essential coverage as a result) or due to enrollment in a QHP through the Exchange, the new election changes permitted by Notice 2022-41 are optional—that is, the sponsor is permitted, but is not required, to adopt these election change changes as a part of its cafeteria plan. The permissible election change events under both notices apply only to group health plan coverage that provides minimum essential coverage within the meaning of the ACA (generally, this is the employer’s medical coverage), and both notices are clear that election changes to health flexible spending arrangements (health FSAs) are not permitted as a result of these events.

For a sponsor wishing to adopt this new election change opportunity, it must amend its cafeteria plan on or before the last day of the plan year in which the new elections are allowed. Although the amendment may be effective retroactively to the first day of that plan year, the plan must operate in accordance with the notice and the employer must inform participants of the amendment. For a plan year that begins in 2023, an amendment may be adopted any time on or before the last day of the plan year that begins in 2024.

Cafeteria Plans Eligible for Amendment

By its terms (in the “Guidance” section on page 11), Notice 2022-41 purports to offer this new mid-year election change opportunity only to “non-calendar year cafeteria plans.” The apparent rationale for this appears on pages 8 and 9, as follows (with emphasis added):

In many instances, the current rules for changes in status would not restrict employees’ and related individuals’ choices regarding coverage. For a related individual enrolled in a calendar year group health plan through the cafeteria plan offered to an employee, the employee may revoke the related individual’s coverage under the plan during the plan’s annual open season at the end of the plan year so that the related individual generally may immediately begin coverage the next calendar year under a QHP, enrolling during the Exchange’s annual open enrollment period. However, a related individual enrolled through a cafeteria plan in a group health plan with a non-calendar plan year might not be able to synchronize the change in coverage to avoid either an overlapping period of coverage or a gap in coverage because the existing cafeteria plan change-in-status rules do not allow the revocation of coverage when only related individuals, and not the employee, become eligible to enroll in a QHP through an Exchange.

However, we can imagine situations in which a participant in a calendar year plan could benefit from the application of this new election change event. For example, assume a participant elected family coverage during the employer’s open enrollment period held in late 2022 for coverage effective January 1, 2023. Assume further that the participant’s family members have become eligible for a premium tax credit on the Exchange in 2023 (under the new rules set forth in the regulations discussed above) and they enroll in Exchange coverage on January 14, 2023 during the Exchange annual open enrollment period (held November 1, 2022 through January 15, 2023), for Exchange coverage likely effective February 1, 2023 (see Official Health Insurance Guide | HealthCare.gov). Without the new flexibility permitted by Notice 2022-41, this participant would not be permitted to drop the employer’s group health plan coverage for their family members who enrolled in Exchange coverage effective on February 1.

We note that, in multiple informal communications with the IRS, it appears that the IRS intended to extend the flexibility provided in Notice 2022-41 to calendar year plans. However, in light of the clear language in the “Guidance” section of the notice, we currently are unable to provide assurance that this election change opportunity may be adopted for a calendar year plan. Thus, published clarification from the IRS on this point would be welcomed.