Part of the new Affordable Care Act (ObamaCare) requires health insurers in the individual and small group markets to spend at least 80% of health care premiums they collect on health care services and activities to improve the health care quality of their customers. In the large group market, the percentage required to be spent is 85. This part of the act is referred to as the Medical Loss Ratio (MLR) rule and it can have an impact on payroll. If a health insurer does not spend at least 80% of the premiums collected on the customers health care services and related areas, the insurer must rebate the difference back to that premium payer. In turn, those rebate dollars can have payroll consequences.
Any MLR rebate will be determined after the end of the customers policy year. If a company is due a rebate, they will receive it in the form of cash or a reduction in their current premiums. The key factors involved in determining the rebates impact on payroll are the tax status of the premium deduction (pre-tax or after-tax) and the percentage of the premium paid by the employee.
If the employee pays 50% of their health care premium, they are only entitled to 50% of the rebate. The company receives the other 50%.
When the after-tax premium for the prior year is being rebated, whether it is given to the employee as a credit on current year’s premiums thus reducing the premiums deducted from his check, or as a cash rebate, the rebate is not taxable. The employee has already paid taxes on his compensation and used part of that after-tax income to pay his/her portion of the premium. Thus they have already paid taxes on any rebate received.
If the employee deducted his/her premiums on their Form 1040 for the prior year, the rebate is still not subject to federal employment taxes but is taxable to the extent that he/she received a tax benefit from the deduction.
If the health insurance premium is pre-tax (it is a 125 plan), when the pre-tax premium for the prior year is rebated, whether it is credit or cash, the rebate is taxable. If the rebate is applied as a credit to this year’s premium, it is in essence taxable because it reduces the employees deduction, thus increasing their taxable wages. If the rebate is a cash rebate, it needs to be added to his/her earnings as a taxable wage simply as miscellaneous income. It does not require any special distinction on the W-2.
If you have any questions regarding the MLR, please feel free to contact one of our payroll specialist at 423-854-9042 or firstname.lastname@example.org.