Tax Treatment & Overview of Medical Loss Ratio Rebates
Author: Keith Foster
The IRS has issued a list of medical loss ratio (MLR) frequently asked questions as a guide to the tax treatment of rebates. In general, if an employee paid insurance premiums on an after-tax basis and then received a rebate—in the form of either cash payment or a premium reduction—the rebate would not be subject to income or employment tax. If premiums were paid on a pre-tax basis under a cafeteria plan, the rebate would be subject to tax. A cash payment would increase employee wages and be subject to employment taxes. A premium reduction would decrease an employee’s pre-tax deductions thereby increasing taxable wages for both income and employment tax purposes.
Recently, insurers have distributed refund checks based on requirements in the Patient Protection and Affordable Care Act, which states that at least 85 percent (80 percent in some cases) of premium revenues must be spent on health care costs and health care improvement activities. This percentage, known as the medical loss ratio, excludes expenses for administration and marketing. For each policy, if the insurer spends less than 85 percent of premiums on qualifying health care costs, it is required to issue a rebate to the policyholder in the form of a premium credit or cash payment. Both the rebate and a notice containing MLR information were provided to the policyholder by August 1. A notice also was provided to all plan enrollees. In addition, certain MLR data becomes public information after an MLR report is filed with the Department of Health and Human Services (HHS) and is available here.
Additional Information on ERISA-Covered Plans
Most—but not all—group health plans are governed by the Employee Retirement Income Security Act (ERISA). Employers with ERISA plans must determine if the rebate qualifies as a plan asset. According to Technical Release 2011-4 issued by the U.S. Department of Labor, a rebate is a plan asset if the plan or its trust is the policyholder, or if the employer is the policyholder and premiums were paid out of trust assets, unless a specific plan or policy addresses rebate distributions. Also, if the employer was the policyholder and premiums were not fully paid out of trust assets, i.e., the employer paid part of the premiums from its general assets, the rebate is a plan asset to the extent of premiums paid by plan participants.
The portion of MLR rebate determined to be a plan asset must be exclusively used for the benefit of the plan’s participants and beneficiaries. The rebate can be distributed to participants or applied toward future premium payments or benefit enhancements. Employers with multiple policies must take care to allocate the rebates to the proper health plan. In addition, employers who do not maintain a health plan trust should ensure any rebates are used within three months to avoid violating ERISA.
Additional Information on Non-Federal Government Plans
Non-federal governmental plans, including state and local governments, must use the employee portion of the rebate for the benefit of covered employees. Interim final regulations issued by the HHS state that benefits may include a reduction to the enrollees’ portion of the annual premiums in the year the rebate is paid or a cash refund to those covered by the group health policy for which the rebate is based.
Additional Information on Other Nongovernmental, Non-ERISA Plans
Final regulations issued by HHS address nongovernmental, non-ERISA plans, such as church plans. Rebates for these plans will be issued directly to the enrollees unless the policyholder provides written assurance to the insurer that the rebates will be used for the benefit of the enrollees.
For more information on these rebates or the MLR, contact your BKD advisor or Chris Doolittle.