The first round of medical loss ratio (MLR) rebates payable under the Patient Protection and Affordable Care Act (PPACA) (P.L. 111-148) have now been either recently received or are "in the mail." The first MLR rebates under the PPACA were required to be disbursed to health insurance policyholders by insurance companies on or before August 1, 2012.
In April 2012, the IRS posted frequently asked questions (FAQs) addressing the federal tax consequences of MLR rebates. These FAQs form the framework and extent of IRS guidance to date. The basic rule of thumb throughout the various scenarios addressed by the FAQs is fairly straightforward: if a tax benefit was previously gained on the premiums now being refunded, the rebate is taxable; otherwise, the premiums are usually tax free to the recipient.
The guidance confirmed that where employees make premium contributions with pre-tax dollars through a cafeteria plan, any MLR rebates that the employer passes through to those employees will be subject to federal income and employment taxes, and related employer wage withholding obligations, in the year that they are paid, Fenton told CCH. "This is true regardless of whether the rebates are distributed in the form of cash or future credits against premiums (for example, credits produce more taxable wages)."
Individually-purchased policies. An individual who purchased and paid premiums for health insurance for himself or herself in 2011, without receiving any reimbursement or subsidy for the premiums, will not be taxed on any rebate received in 2012, provided the individual did not receive a tax benefit from deducting the 2011 premiums on 2011 Form 1040, Schedule A or, if self-employed, on line 29 of 2011 Form 1040. The same result applies whether the rebate is received in cash or as a reduction in the amount of premiums due for 2012.
Group policies—after-tax premium payments by employee. As is the case for individually-purchased policies, employees who in 2011 paid their share of the premiums on group policies with after-tax wages (income already taxed and subject to employment taxes) generally will not recognize income on 2012 MLR rebates. For employees who participated in the plan during 2011 and 2012 paying after-tax premiums, the rebates—whether paid in cash or as a reduction in 2012 premiums—will be income tax free to them, except to the extent they benefited from deducting the premium on 2011 Form 1040.
One twist for group plans applies, however, that is dependent upon whether, under DOL rules, the employer shares the rebate from the insurance company with current employees regardless of whether they participated in the 2011 plan. If the employer pays out the rebate based on the employee’s after-tax share of 2012 premiums irrespective of whether the individual was an employee in 2011, the employee receives the rebate as a tax-free purchase price adjustment to 2012 premiums paid. This tax-free treatment applies both to 2012 employees who were employees in 2011 and those who were not and, therefore, irrespective of whether any 2011 premiums were deducted on Form 1040, Schedule A.
Group policies—pre-tax premium payments by employee. MLR rebates are generally taxable if distributed to 2012 participants who pay premiums on a pre-tax basis under the employer’s cafeteria plan. If a 2011-2012 employee who paid in pre-tax premiums receives a rebate check, it is considered a return of wages that have not yet been taxed or subject to employment tax. If that employee receives the rebate in the form of a 2012 premium reduction, the employee’s payment of premiums through a salary reduction contribution in 2012 is decreased by that amount and therefore taxable salary is increased by that amount.
If an employer pays out rebates in 2012 irrespective of whether an employee under the cafeteria plan had worked for the employer in 2011, the MLR rebate is likewise considered addition income and subject to employment taxes. If paid in cash, it is considered additional wage income. If paid as a premium reduction, it is considered a reduction in the pre-tax amount due by the employee under the cafeteria plan and, therefore, increases wage income.
Information reporting requirements
Cash rebates to individual policy holders generally are subject to Form 1099-MISC information reporting by the insurance company only if two conditions are met: (1) the total rebate payments made to that policyholder for the year total $600 or more; and (2) the insurance company "knows that the rebate payments constitutes taxable income to the individual policyholder or can determine how much of the payments constitute taxable income."
Rebates paid to a group policyholder as a premium reduction likewise are not subject to Form 1099-MISC information reporting under the same criteria as for cash rebates, above (the premium reduction is for $600 and the insurance company knows it will be taxable income to the group policyholder) and the group policyholder is not an exempt recipient for Form 1099 purposes. An exempt recipient includes corporations, tax exempt organizations, and federal/state governments.
Rebate payments passed along by employers to employees under a cafeteria plan, either as cash or premium reductions, will normally be reflected on each employee’s Form W-2 as increased wage income, subject to income tax withholding and employment taxes.