ACA News & Publications

ACA Pathways: Proposed Regulations Address Implications Of Cash Opt-out Payments To Employees

July 27, 2016

The Internal Revenue Service (IRS) recently issued proposed regulations relating to the health insurance premium tax credit (subsidy) and the individual shared responsibility penalty under the Affordable Care Act (ACA). Included in these regulations were rules regarding the impact of "opt-out" arrangements on the affordability of employer-sponsored health coverage, and thus, the determination of an employee's eligibility for a subsidy in the Marketplace, and for employers subject to the ACA's employer shared responsibility requirement ("play or pay" or "employer mandate"), the potential for a penalty assessment under Internal Revenue Code (Code) Section 4980H(b), and having to comply with the informational reporting requirements under Code Section 6056 (in particular Form 1095-C).

Under Code Section 4980H(b), in general, an employer with at least 50 full-time equivalent employees (applicable large employer) may be subject to a penalty for each month that the employer fails to offer a full-time employee "affordable" health coverage that provides at least 60 percent minimum value. Under IRS safe harbors, coverage is deemed affordable as long as the employee's required contribution for the lowest cost option for employee-only coverage does not exceed 9.5 percent (as indexed) of the employee's required contribution for that coverage. For 2016, the indexed amount is 9.66 percent. For 2017, the percentage increases to 9.69 percent. The penalty assessment is triggered when, in lieu of enrolling in the employer's health coverage, a full-time employee enrolls in a qualified health plan purchased through the Marketplace, and receives a subsidy.

Under Code Section 6056, applicable large employers must also provide annual statements to their full-time employees and file with the IRS regarding the health coverage these employees were offered.

Opt-out Arrangements

In general, under an opt-out arrangement (also referred to as "cash-in-lieu"), an employer makes a payment available to an employee:

  • If the employee declines coverage (including waiving coverage in which the employee would otherwise be enrolled) under his or her employer's group health plan; and
  • The payment cannot be used to pay for coverage under the employer plan.

Examples of common opt-out arrangements include:

  • Providing additional flex credits to an employee who declines core coverage, which can be used to purchase non-core benefits;
  • An arrangement permitting an employee to apply his or her flex credits to a 401(k) plan; or
  • Providing an incentive payment for declining employer-provided health coverage.

Opt-out arrangements can be unconditional or conditional, and are generally treated as taxable income to the employee.

Unconditional Opt-Outs

An unconditional cash-out arrangement is an arrangement in which the employer provides an employee a payment conditioned solely on his or her declining coverage under its health plan without requiring the employee to satisfy any other meaningful requirement related to an employer's provision of health care to its employees, such as a requirement to provide proof of coverage in a spouse's employer's health plan. Late last year, in Notice 2015-87 (Q/A-9), the IRS indicated that for purposes of determining whether an employer-sponsored health plan is affordable, an unconditional cash-out payment will generally increase an employee's required contribution beyond the amount of salary reduction elections, thus having the effect of increasing the cost of self-only coverage for determining whether the coverage is affordable and incurring a potential play or pay penalty.

These proposed regulations adopt the IRS position in Notice 2015-87 and confirm that an unconditional opt-out payment will increase an employee's required contribution for purposes of determining affordability under the employer mandate.

Transitional relief exists for unconditional opt-out arrangements adopted prior to December 16, 2015 until final regulations are issued. Thus, employers are not required to treat opt-out payments (other than payments under arrangements adopted after December 16, 2015) as increasing employees' required contributions for employer shared responsibility purposes (or for information reporting under Code Section 6056).

Conditional Opt-Outs

A conditional opt-out arrangement is an arrangement in which receipt of a cash-out payment requires that the employee decline employer-sponsored coverage, as well as satisfy additional conditions (such as providing proof of having alternative coverage, such as coverage provided by a spouse's employer).

Notice 2015-87 did not address the impact of conditional opt-out arrangements on the affordability of employer-sponsored health coverage, or with respect to eligibility for a subsidy, but indicated that the IRS intended to provide future guidance on the issue. Under these new proposed regulations, in contrast to an unconditional opt-out arrangement, the IRS is proposing that a conditional opt-out arrangement will not increase an employee's required contribution for purposes of determining the affordability of an employer's health coverage, as long as it is an "eligible opt-out arrangement". Under an eligible opt-out arrangement, the employee's right to receive the payment is contingent on all of the following requirements being met:

  • The employee must decline to enroll in the employer's health plan;
  • The employee must provide reasonable evidence that the employee, as well as those whom he or she expects to claim as a personal exemption deduction on his or her tax return for the year (the employee's tax family)) have or will have other minimum essential coverage during the period to which the opt-out arrangement;
  • The alternative coverage must NOT be coverage in the individual market, including the Marketplace (e.g., Covered California);
  • Reasonable evidence of alternative coverage could include an attestation by the employee, or other reasonable evidence, that the employee and his tax family members will have minimum essential coverage (other than individual coverage);
  • The employee must provide evidence of alternative coverage (or intent to enroll in alternative coverage) at least annually, and should be provided no sooner than a reasonable period before the commencement of the plan year to which the opt-out payment applies (e.g., during open enrollment). It also could be provided soon after the plan year begins, to enable the employer to confirm actual enrollment in the alternative coverage; and
  • An opt-out payment cannot be made if the employer has reason to know that the employee (or any member of his or her tax family) does not have (or will not have) the required alternative coverage.

Effective Date

The new regulations are proposed to be effective for plan years beginning on or after January 1, 2017 (final regulations are anticipated to be issued prior to the end of this year). Until then, employers are not required to include opt-out arrangements adopted prior to December 16, 2015 when determining the affordability of their health coverage.

In addition, transition relief applies to those opt-out arrangements under collective bargaining agreements that were in effect prior to December 16, 2015, until the later of either (1) the first plan year that begins following the expiration of the collective bargaining agreement, or (2) the effective date of the final regulations.

Employer Action Items

Employers currently offering cash opt-out arrangements should review their plan design provisions and assess the extent to which changes, if any, may be required to ensure the coverage offered to their employees is affordable to avoid incurring a potential play or pay penalty. In addition, employers will need to accurately report the cost of employer-provided health coverage on their employees' Forms 1095-C, and, if applicable, include the cost of any ineligible opt-out payment made. Thus, they also will need to properly communicate this information to their payroll vendors or other third party administrators responsible for the reporting function. Examples of eligible/ineligible design options include the following:

Eligible Opt-Out Arrangements Ineligible Opt-Out Arrangements
  • Opt-out arrangements contingent on employee and family members enrolling in alternative group health coverage that meets the requirements set forth in the proposed guidance
  • Unconditional opt-out arrangement adopted prior to December 16, 2015 (until 2017 plan year)
  • Opt-out arrangements subject to collective bargaining agreements in effect as of December 16, 2015 (until 2017 plan year, or termination of collective bargaining agreement, if later)
  • Unconditional opt-out arrangements to the employee
  • Unconditional opt-out arrangements to the employee’s spouse
  • Conditional opt-out arrangements that permit an employee and/or his or her tax family member to enroll in individual coverage, including Marketplace coverage

The proposed final regulations are available at

Notice 2015-87 is available at

For More Information
For more information about this ACA Pathways or about any other health care reform-related provisions, please contact your Burnham Benefits consultant or Burnham Benefits at:

Burnham Benefits

This ACA Pathways is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel for legal advice. The information contained in this ACA Pathways includes emerging health care news from a limited perspective and does not encompass all views. The information was selected from a wide range of sources selected on the basis of their potential impact on employers and/or their employee benefit plans. For more information, please contact Burnham Benefits.

Back to News & Publications