Current developments in employee benefits and pensions.

• Author: Walker, Deborah
• Position: Part 1

This two-part article covers significant developments in late 2009 and 2010 in employee benefits, including executive compensation, health and welfare benefits, qualified plans, and employment taxes. Part I discusses employment taxes, including the Hiring Incentives to Restore Employment (HIRE) Act and medical resident FICA refund claims, and provides an overview of the health care reform legislation, (1) which President Obama signed into law in March 2010, focusing on guidance released and provisions that require immediate employer-related changes. Part II, in the December issue, will cover updates and changes to the rules for qualified retirement plans.

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The Affordable Care Act--Small Business Provisions

Small Business Health Care Tax Credit

Small businesses and tax-exempt organizations that provide health care coverage to their employees will be eligible for a special income tax credit for health insurance premiums they pay for their employees under the Patient Protection and Affordable Care Act (PPACA). (2) Eligible employers can claim the credit as part of the general business credit starting with the 2010 income tax return they file in 2011. The IRS has released a draft Form 8941, Credit for Small Employer Health Insurance Premiums, which employers will attach to their tax returns to claim the credit.

In order to be eligible for this credit, (1) the employer must have fewer than 25 full-time equivalent employees (FTEs) for the tax year, (2) the average annual wages of its employees for the year must be less than $50,000 per FTE, and (3) the employer must pay at least half of the insurance premiums for the employees at the single (employee-only) coverage rate. (3)

The number of an employer's FTEs is determined by dividing the total hours of service for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee) by 2,080. The credit is specifically targeted to help small businesses that employ primarily low and moderate income workers. Generally, seasonal workers, family members, a sole proprietor, a partner in a partnership, a shareholder owning more than 2% of an S corporation, and any owner of more than 5% of other businesses are not considered employees for purposes of the credit. (4)

The amount of average annual wages is determined by first dividing (1) the total wages paid by the employer during the employer's tax year to employees taken into account in determining FTEs by (2) the number of the employer's FTEs for the year. (5)

The maximum credit is 35% of premiums paid in 2010 by eligible small business employers and 25% of premiums paid by eligible employers that are tax-exempt organizations. (6) In 2014, this maximum credit increases to 50% of premiums paid by eligible small business employers and 35% of premiums paid by eligible employers that are tax-exempt organizations. The maximum credit goes to smaller employers--those with 10 or fewer FTEs--paying annual average wages of $25,000 or less.

Cafeteria Plan Nondiscrimination Safe Harbor for Small Employers

Beginning in 2011, small employers (generally those with 100 or fewer employees) will be allowed to adopt new simple cafeteria plans, which are conceptually similar to simple 401(k) plans and simple IRAs under current law. (7) In exchange for satisfying minimum participation and contribution requirements, these plans will be treated as meeting the nondiscrimination requirements that would otherwise apply to the cafeteria plan. By offering health care coverage through simple cafeteria plans, small employers, including owners and highly compensated employees, may obtain more benefits--potentially discriminatory benefits--without running afoul of the nondiscrimination requirements of classic cafeteria plans.

Small Employer Workplace Wellness Program

Grant money will be awarded to small employers who implement a "comprehensive workplace wellness program." (8) The grant program will provide $200 million over a five-year period, beginning in 2011. Eligible employers are those that employ fewer than 100 employees with 25 hours or more per week and that did not provide a workplace wellness program as of March 23, 2010. To qualify as a comprehensive workplace wellness program, a wellness program must be available to all employees and include health awareness initiatives such as health education and health risk assessments, initiatives to change unhealthy behaviors, and mechanisms to encourage employee participation.

The Affordable Care Act--Immediate Changes

The sweeping changes made by the health care reform legislation will become effective over the course of several years. However, some of the employer-related changes will become effective as early as the first plan year that begins on or after September 23, 2010 (January 1, 2011, for calendar-year plans). These "first-up" changes will impose the following on group health plans:

* Expansion of dependent coverage;

* Prohibition on excluding children based on preexisting conditions;

* Coverage of preventive health services without cost-sharing requirements;

* Limitations on rescission practices; and

* Regulation of annual and lifetime limits on essential health benefits.

Each provision will be discussed in detail below.

While insurance policies that were in effect on the date of enactment (March 23, 2010) are generally grandfathered (for both the current term and any renewal terms), four of the five aforementioned insurance market reforms apply to grandfathered plans. (9) Thus, except for the preventive health services coverage requirement, these principal reforms are effective for all plans for plan years beginning on or after September 23, 2010. (10)

Some programs established under the PPACA are already effective. For example, the reinsurance program for early retirees (by which participating employer plans are reimbursed a portion of the cost of providing health insurance coverage to early retirees) became effective on the date of enactment. (11) Employers who are accepted into this program can submit claims for their retirees, and these claims will be processed in the order in which they are received. (12) They will be reimbursed for costs incurred on or after June 1. (13) The program is set to expire on January 1, 2014 (or possibly earlier, when the $5 billion in federal funding is exhausted). (14)

As discussed above, for tax years beginning in 2010, a special tax credit is available for small businesses and tax-exempt organizations that provide health insurance coverage to their employees.

Other notable changes will soon be effective as well. For tax years beginning in 2011, nonprescription drugs will no longer be reimbursable by health FSAs, Archer MSAs, health reimbursement accounts (HRAs), or health savings accounts (HSAs). (15) Beginning in 2011, nonqualified distributions from HSAs and Archer MSAs will be subject to an excise tax of 20% (increased from 10% for HSAs and 15% for Archer MSAs). (16) Also beginning in 2011, employers will be obligated to report the cost of providing employer-sponsored health care on Form W-2. (17)

Grandfathering Rules

Setting the parameters for group health plans that are seeking to avoid some of the mandates imposed by the PPACA, the Departments of Health and Human Services (HHS), Treasury, and Labor (DOL) have published guidance for identifying and maintaining "grandfathered" health plans. (18) The regulations are generally effective on June 14, 2010, although a transition period and good-faith compliance apply. Some highlights of the regulations:

Retiree-only and excepted benefit plans are excluded: The preamble provides an exercise in statutory construction as it relates the changes made by the PPACA to the Employee Retirement Income Security Act of 1974 (ERISA), the Internal Revenue Code, and the Public Health Service Act (PHSA). (19) It clarifies that the individual and group market reforms of the PPACA do not apply to very small plans (i.e., those with fewer than two participants who are current employees), retiree-only plans, or plans that provide only excepted benefits (e.g., dental-only plans, vision-only plans, most health care flexible spending arrangements). (20) HHS further states that it will exclude from its enforcement efforts non-federal government plans that are retiree-only plans or excepted benefits. (21) Along the same lines, HHS encourages states not to apply the market reforms to issuers of retiree-only plans or excepted benefits. (22)

Grandfathered plan defined: Several general elements apply in determining whether a health plan is grandfathered, (23) including:

* Continuous coverage: The plan must have continuously covered someone (not necessarily the same person) since March 23, 2010, the date of enactment of the PPACA. This means that, even if all the individuals who were enrolled in the plan on March 23, 2010, cease to be covered, the plan could still qualify as grandfathered if it continuously covers someone.

* Determination made for each benefit package: The determination of whether the requirements are met is made separately for each benefit package under the plan.

* New policy, certificate, or contract of insurance: A plan will cease being grandfathered if it provides coverage under a new policy, certificate, or contract of insurance.

* Disclosure: To maintain grandfathered status, any plan materials provided to participants that describe the plan's benefits (e.g., the summary plan description) must include a statement that the plan believes it is grandfathered. Model language is included in the regulation.

* Recordkeeping: The plan must maintain, for as long as it claims grandfathered status, records documenting the plan terms in effect on March 23, 2010, and any other documents necessary to verify, explain, or clarify its status as grandfathered, and must make such records available on request.

* Enrollment after March 23, 2010: For an...