Health Insurance Update: Is your MLR rebate taxable?

You or your company may have received a check from your health insurance provider in the past couple of months indicating that this check was your MLR rebate.  What is an MLR rebate and is it taxable to your company or to the individual beneficiaries?  A provision in the Patient Protection and Affordable Care Act known as the medical loss ratio (MLR) requirement mandates that health insurance carriers spend 85 percent of their premiums (large group )and 80 percent of their premiums (individual and small group) on direct medical care. Health insurers that do not meet this standard in any calendar year beginning on January 1, 2011, will be required to issue rebates to their policyholders. The first MLR rebates for 2011 have been calculated, and official word on how much they will be and who they will go to was released by the Department of Health and Human Services (HHS) on June 21, 2012. Affected health insurance carriers are required to distribute their rebates by August 1, 2012, along with an accompanying notice to impacted group and individual policyholders. Even if an insurer meets the MLR requirements, it must notify subscribers that no rebate will be issued.

According to the Department of Labor, this rebate must be distributed for the exclusive benefit of participants and beneficiaries in the following three ways:

  • The rebate can be paid to the participants under a fair and equitable allocation method, such as a cash payment to the employees. What is “fair and equitable” is undefined, giving the employer the ability to decide if any premium reduction or cash refund should be divided evenly among the employees based on the actual total premium payment or divided based on a weighted average using the amount each individual employee paid (i.e., single rate versus family rate).
  • The employer can apply the rebate toward future participant premium payments by reducing the impacted employee’s salary reduction contributions for a specified period.
  • The employer can use the rebate to provide enhanced benefits for the participants. Enhanced benefits are not defined, but they are generally believed to mean an improvement to the group health plan’s benefits or providing an enhanced health related benefit to beneficiaries.

When deciding how to pay employee rebates, the plan fiduciary should consider the overall cost to the plan and what may be in the overall plan’s best interest. The DOL suggests that the second and third options should be used only if distributing payments to participants is not cost effective or would result in tax consequences for them. The plan administrator needs to weigh what is both most reasonable cost‐wise for the plan, but also what is the fairest means of distribution for all plan participants and what is in the ultimate best interest for the plan.

The tax treatment of MLR rebates was addressed in a frequently asked questions document issued by the IRS in April 2012. For individual market consumers who purchased their coverage with after‐tax dollars, a rebate is not taxable income. However, if an individual deducted the prior year’s premium payments on their Form 1040 Schedule A, then their MLR rebate is subject to federal income tax.

With regard to employer‐sponsored coverage, if the employee’s share for the impacted premium year was paid for entirely with after‐tax dollars, the rebate is not federal taxable income. However, if the employee paid their share using pre‐tax dollars, such as through a Section 125 plan, it is taxable income.  This is true whether the employee gets a future premium credit or a cash payment. For example, if the employee normally contributes $100 per pay period towards plan premiums via a salary reduction and the employer elects to reduce that contribution to $50 to accommodate a rebate, the employee’staxable salary would correspondingly rise and be taxed. If the employer decides to give impacted employees a cash payment, that payment is also subject to employment taxes.  Though the dollar figures are typically not large, the issue is complicated.  Please contact our office if you have any questions about how to assess the taxability of your MLR rebate.

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