The April 18, 2009 deadline for distributing the notice describing the new COBRA premium reduction and COBRA extended election period available under the American Recovery and Reinvestment Act of 2009 (“ARRA”) has passed, and many employers and plans will begin receiving and administering requests for the premium reduction over the next few weeks. Both the Internal Revenue Service (“IRS”) and Department of Labor have issued helpful guidance on how to administer these new COBRA rights since the enactment of ARRA on February 17, 2009, including the IRS’s Notice 2009–27 (the “Notice”). This article discusses some of the major issues raised in the Notice, including its guidance on what constitutes an “involuntary termination” and the interplay of the premium reduction and coverage provided in connection with a severance policy or plan. (For a detailed discussion of the ARRA premium reduction and the second COBRA election period, please also see our article on the ARRA premium reduction in our February 2009 issue.)
Briefly, ARRA provides for a 65% reduction in the premium otherwise payable for COBRA coverage by certain qualified beneficiaries for coverage periods that commence on and after February 17, 2009 (COBRA months beginning March 1, 2009 for plans that administer COBRA on a monthly basis). The ARRA premium reduction is available for up to nine months to an “assistance eligible individual” (“AEI”) who:
- is a qualified beneficiary (employee and/or spouse or dependent child) who is eligible for COBRA coverage because of an involuntary termination that occurs during the period between September 1, 2008 and December 31, 2009;
- is eligible for COBRA at any time during that period; and
- elects and maintains COBRA coverage.
Qualified beneficiaries who would be eligible for the new premium reduction but for the fact they do not have COBRA coverage as of February 17, 2009, may elect COBRA during a special 60-day extended election period that plans must provide for no later than April 18, 2009.
According to ARRA, employers and plans that must front the portion of the cost of COBRA that is not paid by AEIs may be reimbursed for such cost by claiming a credit against the employer’s payroll tax liability using the new quarterly Form 941.
Because ARRA did not define the term “involuntary termination” for purposes of determining who is eligible for the premium reduction, perhaps the most anticipated guidance expected from the IRS concerned the types of the circumstances that would constitute an “involuntary termination.” The Notice defines an “involuntary termination” as “a severance from employment due to the independent exercise of the unilateral authority of the employer to terminate the employment, other than due to the employee’s implicit or explicit request, where the employee was willing and able to continue performing services.” According to the Notice, the determination of whether a termination is “involuntary” is based on all the facts and circumstances. The Notice identifies the following situations as constituting an “involuntary termination” for purposes of the ARRA premium reduction:
- The employer’s failure to renew a contract at the time the contract expires if the employee is willing and able to execute a new contract providing terms and conditions similar to those in the expiring contract, and to continue providing the services;
- An involuntary reduction to zero hours such as a lay-off, furlough or other suspension of employment, that results in a loss of health coverage;
- Involuntary terminations for cause (note: a termination because of gross misconduct is not a qualifying event for COBRA purposes and, therefore, does not entitle the employee to COBRA or the premium reduction);
- A work stoppage as the result of a lockout initiated by the employer, but not a strike initiated by employees or their representatives; and
- An employer’s action to terminate an individual’s employment status while the individual is absent from work due to illness or disability.
The Notice also addresses employee-initiated terminations. According to the IRS, such terminations may be considered involuntary if the employee’s action is taken in response to an employer action that causes a material negative change in the employee’s employment relationship. Such material negative changes may include the employer’s reduction of the employee’s hours of employment or change in the geographic location of the employee’s work location. Thus, if an employee resigns as a result of the employer’s reduction of the employee’s hours of employment, the employee’s termination may be considered to be involuntary.
Moreover, the Notice specifies that even if a termination is designated as “voluntary,” as a “resignation” or as a “retirement,” the termination may be considered involuntary if the facts and circumstances indicate that, absent such voluntary termination or retirement, the employer would have terminated the employee’s services, and the employee knew that he or she would be terminated. For example, if an employee accepts a severance or buy-out package, the employee will be considered to have been involuntarily terminated if the employer indicates that a certain number of remaining employees in the employee’s group will be terminated after the severance package’s offer period. The Notice also clarifies that the death of an employee is not considered to be an involuntary termination.
Although the Notice states that a reduction in hours (e.g., a leave of absence) will generally not be considered an involuntary termination, the IRS stated in a recent webcast that an employee who commences a military leave may be considered to be involuntarily terminated for purposes of the ARRA premium reduction.
Status as an “Assistance Eligible Individual”
The Notice also includes the following clarifications regarding who may qualify as an AEI:
- To be an AEI, the involuntary termination and eligibility for COBRA must both occur during the period from September 1, 2008 and December 31, 2009. If either of these events occurs before or after these dates, the individual may not be considered an AEI. With respect to employers that provide extended coverage to involuntarily terminated employees that is the same as the coverage provided to similarly situated active employees, the Notice clarifies that the employer’s treatment of that extended coverage will determine whether the terminated employee qualifies for the ARRA premium reduction:
- If an employer provides an employee who is involuntarily terminated on November 15, 2009, with severance benefits that includes six months of extended coverage for which no premium is required for the period from December 1, 2009 through May 31, 2010, the terminated employee will not be considered an AEI if the employer does not count the sixmonth extended coverage period against the terminated employee’s COBRA coverage period. In other words, if no loss of coverage occurs until after the six-month period ends, the individual’s eligibility for COBRA occurs on June 1, 2010 and the individual is, therefore, ineligible for the premium reduction.
- If the employer treats the six-month extended coverage period as part of its COBRA obligation, then the loss of coverage in this example would be considered to have occurred on November 30, 2009, and the individual would be an AEI.
If an employer wishes to take advantage or the premium reduction for upcoming layoffs, the employer may want to restructure severance benefits so that the termination and loss of coverage occur on or prior to December 31, 2009.
- The Notice clarifies that an involuntary termination that follows another qualifying event such as a divorce or a loss of dependent status will not cause the qualified beneficiary to become an AEI.
- An individual may be considered an AEI more than once. Such individual may be eligible for the premium reduction for up to nine-months for each involuntary termination that qualifies the individual as an AEI.
Calculation of the Premium Reduction and Resulting Payroll Tax Credit
According to the notice, the premium amount used to determine the 35% share that must be paid by an AEI is the amount that is actually charged to the AEI. Thus, if an AEI is required to pay 102% of the applicable premium for COBRA coverage absent the subsidy, the AEI will only be required to pay 35% of the 102% of the applicable premium. However, if an AEI is charged less than the maximum COBRA premium, for example because the employer pays all or a part of the cost of COBRA, the AEI will only be required to pay 35% of this lower amount. The employer’s resulting payroll tax credit is, in turn, 65% of this lower amount. We note that the Notice expressly permits an employer to increase the amount charged for COBRA coverage, subject to the maximum amount permitted under COBRA. For example, if an employer charged a lower COBRA premium prior to enactment of ARRA, the employer may decide to increase the COBRA premium to the maximum amount permitted by COBRA to take full advantage of the ARRA premium reduction.
The Notice provides the following example regarding COBRA coverage that is subsidized in part by the employer:
- Employer A provides extended health plan coverage as part of its severance package to involuntarily terminated employees for 6 months at the cost of $200/month. Employer A pays $800/ month towards the cost of COBRA. The 6-month period is part of the terminated employees’ COBRA coverage period. After this 6-month period, terminated employees must pay $1,000/ month for the remainder of the COBRA coverage period. The premium reduction available to involuntarily terminated Employee B, is:
- First 6 months:
- The employee pays $70 (35% of $200)
- Employer A’s payroll tax credit is $130 (65% of $200)
- Next 3 months:
- The employee pays $350 (35% of $1,000)
- Employer A’s payroll tax credit is $650 (65% of $1,000)
The Notice further clarifies that if an employer fully subsidizes the cost of an AEI’s COBRA coverage, for example as part of a severance package, those subsidized months will count against the nine-month eligibility period that applies to that AEI. Moreover, because the AEIs are not actually being charged anything for COBRA coverage, no payroll tax credit will be available to the employer for these subsidized amounts.
- Example: Employer C provides extended health plan coverage as part of its severance package for involuntarily terminated employees for 6 months at no cost. The 6-month period is part of the terminated employees’ COBRA coverage period. After this 6-month period, terminated employees must pay $1,000/month for the remainder of their COBRA coverage periods. The premium reduction available to involuntarily terminated Employee D, is:
- First 6 months:
- The employee pays $0 (35% of $0)
- Employer C’s payroll tax credit is $0 (65% of $0)
- Next 3 months:
- The employee pays $350 (35% of $1,000)
- Employer C’s payroll tax credit is $650 (65% of $1,000)
- After the first nine months of COBRA coverage, no premium reduction applies, and so Employee D can be required to pay $1,000/ month for the balance of his/her COBRA coverage period.
- First 6 months:
The Notice also clarifies that if an employer reimburses an AEI for the subsidized amount he or she must pay for COBRA coverage and the employer excludes that amount from the AEI’s gross income under IRC Section 106, the AEI’s COBRA payment will be treated having been paid by the employer and no payroll tax credit will be available to the employer. On the other hand, if an employer provides taxable severance monetary benefits to an involuntarily terminated employee but does not pay any amount towards the terminated employee’s COBRA coverage, the severance benefit will not be taken into account for purposes of applying the premium reduction.
- Example: Prior to February 17, 2009, Employer F charged $400 per month for COBRA coverage. Employer F charges $1,000 per month for COBRA coverage for periods of coverage beginning March 1, 2009. In addition, beginning March 1, 2009, Employer F provides a taxable severance benefit of $600 per month to employees who are AEIs. In this example, the premium reduction is based on the $1,000 per month charge and:
- The employee pays $350 per month (35% of $1,000)
- Employer F’s payroll tax credit is $650 (65% of $1,000)
To the extent that continuation coverage includes coverage for individuals who are not qualified beneficiaries (e.g., domestic partners or a new spouse who is enrolled during the COBRA coverage period) or who are not AEIs, the Notice makes clear that the ARRA premium reduction does not apply to such coverage. The Notice states that if the COBRA coverage covers individuals who are not qualified beneficiaries or AEIs, the amounts paid for coverage are allocated first to the cost of covering AEIs and then to the cost of covering non-AEIs. Therefore, if the cost of covering non-AEIs is $0, the ARRA premium reduction will apply to the entire amount paid for the COBRA coverage. However, if the cost of covering a non-AEI adds to the cost of covering AEIs, then the incremental cost is not eligible for the premium reduction.
- Example: Employee G is an AEI and has employee-only COBRA coverage with a premium of $450 per month. Employee G is paying $157.50/month (35% of $450/month). Employee G marries Spouse H, and enrolls her and her 3 daughters in the plan. The COBRA cost for selfplus- 2-or-more dependents is $1,000/month. The spouse and children are not qualified beneficiaries or AEIs because they were not covered by the plan on day before Employee G’s involuntary termination.
- Employee G pays 157.50 per month (35% of $450) for the premium attributable to his employee-only coverage.
- Employee G pays an additional $550 per month for the premium attributable to coverage for his spouse and children ($1,000 – $450)
- The employer’s payroll tax credit is $292.50 (65% of $450)
Coverage Eligible for the ARRA Premium Reduction
In addition to clarifying that the ARRA premium reduction applies to vision-only and dental-only plans and to health reimbursement arrangements (“HRAs”), the Notice addresses retiree health plan coverage. According to the Notice, if retiree health plan coverage does not differ from the coverage provided to similarly situated active employees (i.e., it is identical) and does not cost more than the maximum amount allowed under federal COBRA (i.e., 102% of the applicable premium), the retiree coverage can be treated as COBRA coverage and covered retirees who qualify as AEIs may receive the ARRA premium reduction.
End of the ARRA Premium Reduction Period
The ARRA premium reduction applies until the earliest of:
- the first date the AEI becomes eligible for other group health plan coverage or Medicare coverage;
- nine months after the first day of the first month for which the ARRA premium reduction applies to the AEI;
- the date the individuals ceases to be eligible for COBRA coverage; or
- the failure to timely pay the required premium for COBRA coverage.
With regard to the cut-off due to eligibility for other coverage, the Notice clarifies that if an AEI is eligible for other coverage (e.g., coverage under a spouse’s employer’s plan) but is not actually able to enroll in the other coverage and have that coverage take effect immediately, the AEI will maintain eligibility for the premium reduction until the first date that the other coverage can take effect.
- Example: Employee K is involuntarily terminated on Nov. 15, 2008 and lost coverage on Nov. 30, 2008. Following the loss of this coverage, Employee K is eligible to enroll in the plan sponsored by his spouse’s employer during a special enrollment period. Employee K elected COBRA through his employer’s plan as of Dec. 1, 2008 and has not been eligible to enroll in his spouse’s employer’s plan on or after Feb. 17, 2009. The spouse’s plan has an open enrollment period from June 1, 2009 through June 21, 2009 for coverage beginning July 1, 2009. Employee K is eligible for the premium reduction as of March 1, 2009 and will continue to be eligible until July 1, 2009 — the first opportunity he has to enroll in his spouse’s employer’s plan and have that coverage take effect. Employee K will cease to be eligible for the premium reduction for COBRA months beginning after June 30, 2009.
The Notice further clarifies that if an individual is offered COBRA coverage and retiree health plan coverage that is not COBRA coverage, the retiree health plan coverage will not render the individual ineligible for the premium reduction if the retiree coverage and COBRA coverage are offered under the same group health plan, as determined by the instruments governing the coverage.
With regard to Medicare, the Notice clarifies that an individual who is currently enrolled in Medicare, but who is eligible to elect COBRA coverage (e.g., because the individual enrolled in Medicare prior to his/her involuntary termination), will not be eligible for the premium reduction.
As referenced in the introductory section of this article, employers and plans may claim a payroll tax credit with respect to AEIs who receive the premium reduction. Accordance to the Notice, if an AEI fails to notify the plan of his/her eligibility for other coverage and continues to receive the premium reduction, albeit improperly, the employer or plan will not be required to refund to the IRS the payroll tax credit that it received, unless the employer or plan had knowledge of the individual’s eligibility for other coverage or Medicare coverage.
Extended Election Period
The Notice clarifies that if an individual was terminated between Sept. 1, 2008 and Feb.17, 2009, and still has an open COBRA election period as of February 17, 2009, the individual can elect COBRA during the extended election period or during his or her original COBRA election period.
- Example: Employee J is involuntarily terminated in Dec. 2008 and loses coverage as of Dec. 31, 2008. Employee J received her COBRA election notice in January 2009. As of Feb. 17, 2009, Employee J has not elected COBRA. Employee J is entitled to a notice about the extended election period.
- Employee J may elect COBRA under her original COBRA election period with COBRA coverage effective as of January 1, 2009; or
- Employee J may elect COBRA during the extended election period for the coverage periods beginning on or after Feb. 17, 2009.
The Notice further clarifies that any COBRA coverage that is elected pursuant to the extended election period begins with the first period of coverage beginning on or after February 17, 2009 (March 1, 2009 for plans that administer COBRA coverage as of the beginning of each month). This means that expenses incurred after the AEI’s loss of coverage and before this date (generally, March 1, 2009), are not covered under the resulting COBRA coverage.
Assistance Eligible Individuals
The Notice clarified that the ARRA premium reduction could not apply to individuals who are not qualified beneficiaries under COBRA. The Notice states that a qualified beneficiary with respect to a covered employee under a group health plan is the spouse of the employee under Federal law or a dependent child of the employee under Federal law if, generally, the spouse or dependent child was a beneficiary under the plan on the day before the qualifying event. (A qualified beneficiary also includes a child who is born to or adopted by the covered employee during the period of COBRA continuation coverage.)
Under the Federal Defense of Marriage Act (DOMA), a spouse does not include a domestic partner. Hence, a domestic partner will never be eligible for the ARRA premium reduction. COBRA does not define the term “dependent child.” While “dependent child” is defined in Internal Revenue Code Section 152, that definition is not necessarily applicable to the ARRA premium reduction. In a recent webcast, the IRS acknowledged that the term “dependent child” was not defined in ARRA. Accordingly, we believe that it is reasonable to assume that for the purposes of the ARRA premium reduction the term “dependent child” is determined by reference to the terms of the group health plan.
Notice 2009–27 provides welcome guidance to employers and plans on the administration of the new COBRA premium reduction. If you have any questions regarding the premium reduction, please contact our office.