Overview of Code Section 105(h) / Public Health Service Act Section 2716
Employer-sponsored group health plans receive a special tax exemption under federal tax law. However, this tax break comes with a major caveat: the plan must not discriminate in favor of "highly compensated individuals" or "HCIs". On this page we provide Frequently Asked Questions about how these rules work.
1. What plans are subject to these nondiscrimination rules? All self-funded group health plans are subject to these rules. In addition, many -- but not all -- non-grandfathered, fully-insured group health plans are also subject to these rules.
2. What is a "group health plan"? A group health plan generally includes any employer-sponsored medical plan, such as a major medical plan, a "mini med" plan, a dental plan, vision plan, health reimbursement arrangement ("HRA") or health flexible spending account ("Health FSA"). It usually does not include a health savings account ("HSA").
3. How can I tell if my plan is "self-funded" or "fully-insured"? In general, a plan is self-funded if the employer is liable for paying claims. A plan is fully-insured if an insurer is liable for paying claims. Some self-funded health plans will have "stop-loss" insurance. In this arrangement, an employer will pay the first level of claims (perhaps up to the first $100,000 incurred by an individual) then have an insurer pay the remaining amount. This type of plan is usually considered to be self-funded, not fully-insured.
4. When is a fully-insured health plan "grandfathered"? If a fully-insured group health plan covered at least one individual as of March 23, 2010 (the date the health care reform law was enacted), the plan will be grandfathered. A fully-insured, grandfathered health plan is not subject to the nondiscrimination rules of Section 105(h) of the Internal Revenue Code of 1986, as amended (the "Code") or Section 2716 of the Public Health Service Act ("PHSA").
5. Can grandfathered status be lost? Yes. A variety of changes and other situations can cause a plan to lose its grandfathered status. These include an increase to co-insurance (such as increasing the amount a participant must pay from 20% to 25%), eliminating all coverage for a particular benefit and other plan design modifications if they are significant. For detailed information, contact your attorney or review the federal government regulations (available here).
6. Are the tests under Code Section 105(h) and PHSA Section 2716 identical? They may or may not be identical, but they are going to be similar. The health care reform law (the Patient Protection and Affordable Care Act), enacted on March 23, 2010 created the new PHSA Section 2716 test. That law says that the test will be "similar" to Code Section 105(h). No regulations have yet been issued under PHSA Section 2716. Most people assume that the tests will be similar.
7. Are the penalties for violating the rules identical? No. If a self-funded group health plan fails Code Section 105(h), the penalties are usually imposed on the HCI. For example, suppose an executive who is an HCI receives better benefits than an employee who is not an HCI. The executive would normally be taxed on the value of the better benefits or the value of the coverage.
In contrast, a fully-insured group health plan that violates PHSA Section 2716 will face an excise tax of up to $100 per day per affected individual. Internal Revenue Service ("IRS") guidance indicates that the number of "affected individuals" will be based on the number of plan participants who are not receiving the better benefit. For example, suppose a plan covers 500 individuals. Three of the individuals are HCIs who receive better benefits under the plan than the other 497 individuals. The penalty would apparently be up to $49,700 per day ($100 x 497). There are some exceptions and limits to this penalty.
8. Are some plans not subject to the PHSA Section 2716 test? Yes, it appears so. It appears that certain plans will be "excepted benefits" and avoid the PHSA Section 2716 test. The term "excepted benefits" is defined by another federal law, the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). HIPAA-covered excepted benefits include plans such as retiree-only plans and many fully-insured dental or vision plans.
9. Can 105htest.com LLC advise us on whether our plans are subject to these rules? No. We are not a law firm and do not provide benefits consulting. We encourage you to discuss this question with your attorney, benefit consultant or tax advisor.
10. How does the Code Section 105(h) test (and presumably the PHSA Section 2716 test) work? There are two separate tests, the "Eligibility Test" and the "Benefits Test". The Eligibility Test has three "sub-tests." Passing any one of those three "sub-tests" will allow the plan to pass the Eligibility Test. A plan must pass both the Eligibility Test and the Benefits Test -- they are separate and independent tests.
11. What are the tests under the Eligibility Test? There are three alternative tests that can be used to satisfy the Eligibility Test:
(a) 70% Test -- Does the plan benefit 70% or more of all non-excludable employees?
(b) 70% / 80% Test -- Does the plan benefit 80% or more of all non-excludable employees who are eligible to benefit and are 70% of all non-excludable employees eligible to benefit under the plan?
(c) Nondiscriminatory Classification Test -- Does the plan benefit a group of employees that is nondiscriminatory? This test can be further divided into two sub-tests. These sub-tests use a discrimination test that is usually applicable to qualified retirement plans (Code Section 410).
12. What are the tests under the Benefit Test? The Benefit Test generally examines whether the same benefits are made available to both highly compensated individuals ("HCIs") and non-highly compensated individuals ("Non-HCIs").