Vernoia, Enterline + Brewer, CPA LLC

Is your Medical Loss Ratio (MLR) rebate check taxable? The U.S. Department of Health and Human Services (HHS) estimates that nearly 12.8 million Americans received more than $1.1 billion in MLR rebates during August 2012 based on insurance company shortfalls in cutting overhead during 2011. If you received a rebate, either as an individual policyholder or as an employer or employee, is it taxable?

The first round of annual MLR rebates payable under the Patient Protection and Affordable Care Act (PPACA) (aka ObamaCare) were required to be disbursed to health insurance policyholders by insurance companies on or before August 1, 2012. MLR premium rebates were designed to persuade health insurance companies to spend at least 80 percent of premiums directly on health care as opposed to advertising, certain administrative costs and executive salaries.

The average rebate per household is $151, but with averages ranging from $807 for Vermont to $0 for New Mexico and Rhode Island. Examples of other average household rebates reported by HHS include Calif. ($65), Fl. ($168), N.Y. ($138), Ill. ($380) and Texas ($187). Therefore, while the majority of those estimated 80 million individuals covered by health insurance will not be entitled to the MLR rebates, enough are to raise questions.

Whether a particular MLR rebate paid out this summer is taxable will depend upon a number of variables. Some individuals are receiving their premium rebate checks directly from the health insurance provider. Many more are receiving the rebate payments indirectly from their employers, either as cash payments or in the form of 2012 premium offsets. Some employers are using the rebates to cover plan expenses.

Labor Department rules

Department of Labor Technical Release 2011-04 provides guidance to employers on whether the portion of any rebate attributable to previous employer-paid premiums constitutes plan assets or whether they belong to the employer. Distinctions are made between situations in which the group health plan is considered the policyholder and when the employer is the policyholder, as well as whether contractual terms and the parties’ understandings and representations allow the employer to retain the distribution. DOL guidance also provides employers with some discretion as to how to use or dispose of their MLR rebates, as long as they “act prudently, solely in the interest of the plan participants and beneficiaries, and in accordance with the terms of the plan.”

Federal tax consequences

The basic rule of thumb in determining whether your MLR rebate is taxable is fairly straightforward: if a tax benefit was previously gained on the premiums now being refunded, the rebate is generally taxable; otherwise, the premiums are usually tax free to the recipient.

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 by 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 important exception: 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 additional 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
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.

Rebates that are not considered wage payments generally will only be subject to Form 1099-MISC information reporting if the payment equals or exceeds $600. Payments that are considered taxable must be reported by the individual policyholder irrespective of information reporting requirements.

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