August 1, 2016: This article is being updated for IRS Proposed Regulations (July 8, 2016). It was previously updated (Feb. 22, 2016) for IRS Notice 2015-87, which addresses the treatment of employer opt-out payments for purposes of the Employer Shared Responsibility “Affordability” test, and for other guidance. The updated article will be available soon.
A growing number of employers are offering a “cash in lieu” or “pay in lieu” of benefits option, under which the employer offers an employee a taxable “opt out” amount, if the employee declines coverage under the employer’s group health plan because the employee has coverage under a spouse’s group health plan. Some employers require employees to certify that they have other coverage in order to opt out of the group health plan, while others allow employees to opt out even if they do not certify they have other coverage.
Although it is legal to offer a cash incentive to employees who opt out of the employer’s group health plan, keep in mind that this option will always be taxable. Additionally, there are numerous other important considerations:
- The option should be offered through a cafeteria plan so employees who elect group health plan coverage (not taxable cash) will not have taxable income.
- In 2017, the “cash in lieu” amount will have to be counted in the “affordability” determination under the Affordable Care Act (ACA), unless it qualifies as an “eligible opt out arrangement.”
- In 2016, the “cash in lieu” amount will have to be counted in the “affordability” determination under the Affordable Care Act (ACA), if it was an “unconditional” opt out arrangement and was not adopted before December 16, 2015. But an “unconditional” opt out that was adopted on or before December 16, 2015 will not count in the affordability determination. This will change in 2017.
- In 2016, the “cash in lieu” amount will not have to be counted in the “affordability” determination under the Affordable Care Act (ACA), if it was a “conditional” opt out arrangement, but this will change in 2017 unless the conditional opt out arrangement also qualifies as an “eligible opt out arrangement.”
- The option should not be provided to enable an employee to purchase an individual policy, whether on or off the exchange.
- The option should be offered to all eligible employees, not just to a select few, and should not be offered primarily or exclusively to employees who have high claims.
Employers who are considering an opt-out or “cash in lieu” option should consult with competent benefits counsel to ensure the option is offered in a way that will not result in taxable income to employees or penalties to the employer.
The updated article will be available soon.