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Payroll on the hook for medical loss ratio rebates

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in Office Management,Payroll Management

Group health insurers that don’t spend between 80 and 85 cents of every premium dollar on medical care and health care quality improvement must make so-called medical loss ratio (MLR) rebates to employees, beginning Aug. 1, 2012. The IRS has now clarified that rebates attributable to em­ployees’ pretax contributions are fully taxable.

MLR review

For ERISA-covered plans, rebates of employees’ contributions become plan assets in proportion to the percentages or amounts they paid. For non-ERISA-covered plans, you may collect rebates on employees’ behalf if you provide written assurance to the insurer that the rebates will be used to benefit employees.

Pretax rebate woes

MLR rebates don’t necessarily have to be paid in cash. Insurers can satisfy the rebate mandate by lowering the current year’s premium. Either way, according to the IRS, the rebate is fully taxable.

Example: In 2011, Harry’s share of his health benefits was 40%, which he paid on a pretax basis. On July 1, 2012, he became entitled to an MLR rebate for a portion of his 2011 premiums. The rebate will be a 40% reduction in the current year’s premium. Result: Since Harry’s 2012 pretax contributions are decreased by the amount of his rebate, he has a corresponding increase in his taxable salary. Important: The result is the same if Harry received a cash rebate.

Rebates are taxable to employees who weren’t on the payroll during the previous year. The key, the IRS says, is that they’re on the payroll when the rebate is made.

Example: Jennifer is a new employee whose participation in the plan began in 2012. As a result of the 2011 rebate, and the corresponding premium reduction, Jennifer’s pretax contributions are reduced for the remainder of 2012. Same result: Since Jennifer’s 2012 pretax contributions are decreased due to the rebate, she has a corresponding increase in her taxable salary. Again: The result is the same if Jennifer received a cash rebate.

• PAYROLL PRACTICE TIP: Since rebates attributable to employees’ pretax contributions are fully taxable, good coordination with the benefits department and the insurer is essential. What to avoid: You don’t want the insurer to issue cash rebates directly to employees. Should that happen, you will have to make up the withholding from other payments to employees.

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