A popular middle-class tax benefit could become one of the first casualties
of the Affordable Care Act’s so-called Cadillac tax, affecting millions of
voters.
Flexible spending accounts, which allow people to save their own money tax
free for everything from doctor co-pays to eyeglasses, may vanish in coming
years as companies scramble to avoid the law’s 40 percent levy on pricey health
care benefits.
“They’ll be one of the first things to go,” said Rich Stover, a health care
actuary and principal at Buck Consultants, an employee benefits consulting firm.
“It’s a death knell for them. If the Cadillac tax doesn’t change, FSAs will go
away very quickly.”
That fact alone could dramatically alter the political equation surrounding
Obamacare, potentially blindsiding middle-class voters who may be only vaguely
aware of the Cadillac tax. Though the levy won’t take effect until 2018, it
could be one of the first items on the next president’s desk.
Already, it’s become an issue in the Democratic presidential primaries, with
Sen. Bernie Sanders vowing to junk the tax and Hillary Clinton saying she’s open
to changes. “I worry that it may create an incentive to substantially lower the
value of the benefits package and shift more and more costs to consumers,” she
told the American Federation of Teachers.
Republicans, meanwhile, invoke the tax as one of many reasons to repeal the
entire Affordable Care Act.
“Obamacare continues to overpromise and underdeliver,” said Sen. Dean Heller
(R-Nev.), who also said he is working on legislation to address the issue. “This
tax is devastating to over 33 million Americans annually relying on FSAs and
HSAs [Health Savings Accounts] to limit out of pocket costs and lead healthier
lives.”
The Cadillac tax will cap for the first time the open-ended tax break
employers receive for providing their workers with health benefits. Economists
love the tax because they say that break is a big reason for rising health care
costs. Overly generous insurance coverage shields beneficiaries from having to
worry about the cost of their care, they say, which encourages consumers to use
more services, thus driving up prices.
But the tax is quickly becoming one of Obamacare’s least popular components,
and businesses and unions alike are demanding lawmakers scrap it before it takes
effect.
Opposition cuts across both parties, with half of the House of
Representatives now co-sponsoring one of two bills — one Democratic, one
Republican — that would rescind the levy. House Republican leaders are mulling a
vote on repeal.
Despite widespread complaints over the tax, many observers put long odds on
any repeal, at least this year, because of the administration’s opposition.
Rescinding the tax would also blow a $90 billion hole in the federal budget.
“It seems unlikely,” said Tevi Troy, a conservative health care analyst who
advised Mitt Romney’s presidential campaign. But “the presidential race means we
will have a new dynamic in Washington in 2017.”
The tax applies to benefits worth more than $10,200 for individuals and
$27,500 for families beginning in 2018. While the Obama administration contends
the tax would apply to only a relatively narrow slice of people — thus, the
Cadillac tax nickname — it will hit a growing number of companies because it’s
indexed to a relatively slow measure of inflation.
By 2028, more than half of all employers could potentially face the tax,
according to a report this week by the nonpartisan Kaiser Family Foundation.
The tax applies not only to traditional health insurance but to a swath of
other benefits, including supplemental insurance plans, flexible spending
accounts and, potentially, on-site clinics that employers set up for their
workers.
Many companies have promoted FSAs as a cost-effective way of paying for
things their insurance doesn’t cover. Some businesses use them as an incentive
for workers to participate in fitness programs, for instance, promising to
contribute to the accounts of those who begin exercise regimens.
They’ve become especially popular with large companies, according to Mercer,
a benefits consulting firm. Eighty-eight percent of big companies offer FSAs, it
says, with 22 percent of workers participating. They contribute an average
$1,291.
But FSAs will likely be one of the first benefits cut because they can go a
long way toward determining whether a company will actually pay the tax.
Workers are currently allowed to contribute $2,550 annually, a limit that
grows with inflation. By 2018, that could reach $2,700, which is more than
one-quarter of the $10,200 in individual benefits allowed under the Cadillac
tax. So for some employers, FSAs could decide whether they will have to pay the
tax.
The Kaiser study said this week that companies offering FSAs are far more
likely to pay the Cadillac tax than those that don’t. Twenty-six percent of
employers with FSAs will face the tax in 2018, Kaiser predicts, compared with
just 16 percent of companies that don’t offer them.
The accounts could not only trigger the tax, but quickly run up companies’
Cadillac tax bills.
Stover uses an illustrative example: Say a company offers insurance worth
$11,000 in 2018. The share of that over the $10,200 cap is subject to the tax,
and 40 percent of the $800 difference is $320.
But say one of its employees has contributed $2,700 to an FSA. The company
is already over the limit, so the entire $2,700 is charged the 40 percent tax,
which amounts to $1,080 — quadrupling what the company would otherwise owe. The
employer is charged the tax on its workers’ contributions.
“Why would an employer allow an employee to put money in?” said Stover. “The
employee puts money in to save maybe 25 or 30 percent on their personal taxes,
so the employer can pay a 40 percent excise tax? It doesn’t make any sense.”
That situation irks many companies because they won’t necessarily be able to
control whether they have to pay the tax. They could pare back their insurance
coverage to duck the charge, only to find that an employees’ FSA contribution
still pushes them over, said Rick Grafmeyer, a tax lobbyist who works on the
issue.
“What really grates the employers is that they’re going to potentially fail
this test, and it’s not even their fault,” he said.
The Obama administration defends the tax, saying the Kaiser study
exaggerates its likely impact on FSAs.
“While we have not closely reviewed this study, it is important to note that
it counts an entire employer as affected by the tax if the firm had at least one
plan that could trigger the tax, even if the vast majority of the firm’s workers
are enrolled in other plans and even if an overwhelming majority of the
particular plan’s enrollees would not be affected,” a Treasury spokesperson
said.
“In addition, it does not account for key protections in the law for firms
with older workers or persons in high-risk occupations,” the spokesperson said.
Few companies are dumping their FSAs, at least so far. Many are still
waiting for the IRS to spell out the details on exactly how the Cadillac tax is
going to work. The agency is not expected to issue final regulations until next
year. Many companies are still trying to calculate their potential exposure to
the tax. And many believe Congress won’t allow the tax to take effect, so they
are waiting before making any changes.
Experts have begun discussing possible fixes that would stop short of
repealing the tax to avoid having to overcome a presidential veto.
One possibility would be to allow workers to put only after-tax
contributions into the accounts, and then take an equivalent deduction on their
personal taxes. That would keep the worker whole while sparing the company the
Cadillac tax. But it would also make it harder for people to claim the break,
which could reduce the number of people participating in FSAs. Companies could
also limit how much their workers may put in the accounts, in order to limit
their exposure to the tax.
But Stover says many will likely decide to simply drop the accounts as too
much trouble.
“Come 2018, employers are either going to get rid of FSAs completely, if
they’re at or over the threshold, or if they’re a few thousand dollars away,
they’re going to start capping them,” he said. “But then it almost becomes …
why, if I’m going to cap it and start reducing it over a period of years — why
bother?”