A common question among employers is, “Can we offer employees cash to decline coverage under our employer-sponsored group health plan?” Employers asking this question are typically seeking to reduce benefit costs by incentivizing employees to opt out of coverage under their group health plan. These arrangements/payments, which are often referred to as opt-out credits, cash-out provisions or cash-in-lieu of benefits options, raise several employee benefit compliance considerations of which employers must be aware. Those compliance considerations, which are discussed below, involve some complicated legal issues and, as a result, employers should consult with their employee benefits legal counsel for guidance before implementing such an arrangement.

Cafeteria Plan Requirement

If an employer wishes to offer employees the choice between non-taxable qualified benefits (e.g., accident and health benefits) and taxable wages (e.g., cash), they must do so through a cafeteria plan that complies with section 125 of the Internal Revenue Code (IRC). It follows that if the employer wants to offer employees an additional cash incentive to decline coverage (i.e., offering the employee a choice between electing the employer-sponsored coverage on a pre-tax basis or receiving additional taxable compensation), the arrangement must also be included in a compliant cafeteria plan. Although the arrangement must be offered through the cafeteria plan, any incentive the employee receives in lieu of electing pre-tax coverage must be provided as taxable wages to the employee (i.e., it is subject to income and employment tax withholding). If language regarding the “cash-in-lieu of benefits” option is not included, an employer may need to amend its section 125 cafeteria plan document to incorporate the cash-out feature.

A cash-out arrangement not offered through the employer’s cafeteria plan will result in adverse tax consequences for employees under the doctrine of constructive receipt. In this case, any employee who elects coverage under the employer’s plan will be taxed on the amount of the cash incentive they could have received (despite the fact the employee elected the coverage instead of the cash).

Nondiscrimination

Cash-out arrangements offered through the employer’s cafeteria plan will be subject to the IRC section 125 nondiscrimination rules designed to prevent plans from discriminating in favor of highly compensated employees/ individuals. Specifically, under the Contributions and Benefits Test, the employer contributions apportionable to nontaxable and taxable benefits (including cash incentives) must be available on a nondiscriminatory basis. Employers who do not offer the cash-in-lieu of benefits option to all similarly situated employees on an equal basis will need to ensure that the arrangement is not discriminating in favor of highly compensated employees/individuals.

Regulatory and Legislative Strategy Group