The new COBRA premium assistance provision may prove to be a snake in the grass for many businesses. For the balance of 2009, involuntarily-terminated employees eligible for COBRA continuation coverage will pay only 35% of their COBRA premiums. The employer is obligated to front the remaining 65%. The employer doesn't really go out-of-pocket for such cost, however, because it's entitled to claim a credit on its payroll tax returns. If the COBRA obligation is in excess of its payroll liability, Code Sec. 6432(c)(1) provides “the Secretary shall credit or refund such excess in the same manner as if it were an overpayment of such taxes.”
This is supposed to be about the government subsidizing the cost of health insurance for the swelling ranks of the newly unemployed who would otherwise be unable to afford such coverage. Instead of making the Fed deal with insurance companies directly, the premium subsidy is channeled through the employer. Such administrative efficiency was meant to provide a mechanism for premium payments without significant increase in the employer’s cost.
But a benefit to the terminated employee might wind up causing a venomous bite to the employer. It should be no surprise that a startling number of employers (especially employers now laying off employees) owe back employment taxes. And the above-quoted language suggests that the new COBRA provision can be used as a back door mechanism for collecting these taxes instead of refunding the excess premium to the employer.
Imagine the shock to an employer already struggling with cash flow challenges, now having to pay the 65% COBRA premium, and then discovering that instead of a credit and reimbursement, the reimbursement portion has been applied to oustanding employment taxes for prior quarters. Yes, the employer owed the back taxes, but it never expected to pay the obligation this way.
Employers pyramiding their employment tax liabilities aren't likely to be offering health insurance and, even if they were, aren't apt to comply with their obligation to pay 65% of the COBRA premium. But what of the tens of thousands of small and mid-size businesses who offer health insurance, fall under COBRA, need to lay off workers and happen to owe some back employment taxes? Many of them are on installment agreements and keeping current in their obligations. Yet even they stand to forfeit all or a part of the refund for premium payments in excess of the credit claimed on their payroll tax returns.
Small employer statistics confirm that the potential problem is significant. Sixty two percent of small firms (3–199 workers) offered health insurance benefits in 2008; for the smallest firms bound by COBRA (25 to 49 workers), approximately 90% offered such benefits. Covered workers on average contribute 16% of the premium for single coverage, and 27% of the premium for family coverage (source: The Kaiser Family Foundation and Health Research and Educational Trust 2008 Annual Survey).
While historically the percentage of employees leaving such firms and electing COBRA continuation coverage has been relatively small (29%), this no doubt is a function of having to pay 102% of the full premium to continue coverage. With ARRA now reducing the premium during 2009 to 35%, there will almost certainly be an increase in the percentage of terminated employees electing COBRA coverage. This, in turn, has the potential to spell disaster for any firm caught unaware that the amount it expects to have refunded will instead be applied to past employment tax obligations.
Unfortunately, the Service doesn't seem anxious to mitigate the potential nightmare; in fact, it appears to be exploiting it. Its just-updated “COBRA Questions and Answers: Form Preparation” confirms the worst:
“If an employer with unpaid employment or income taxes claims a credit on Line 12a of Form 941 for the amount of COBRA premium assistance provided during the quarter, and the amount of the credit exceeds the amount of payroll tax liabilities shown on Form 941, the IRS will offset the other unpaid taxes against the balance due before refunding any balance. In this case, the IRS will notify the employer of the offset.”
This is dirty pool. Under these circumstances the Service should not grab refunds from any employer staying current and honoring its installment agreement. And if the Service is allowed to grab the payment, the employer should at least be allowed to treat it as a voluntary payment and designate that it be applied to trust fund taxes.
In any event, careful tax planning is required. At a minimum an employer owing back taxes may want to have a modified 433 at the ready, reflecting the out-of-pocket COBRA expense, loss of reimbursement dollars, and need for a reduced installment payment. Selling the business for fair market value to a new entity (which may be owned by the former owners of the employer) is another option, but such strategy should only be implemented with extreme care to ensure that the transfer satisfies all requirements of law (from license transfers to obtaining new worker’s comp and so forth), isn't a fraudulent conveyance, and doesn't trigger successor liability.
Spotting the problem is an important first step in working around it, but there are bound to be further developments in the coming days and weeks. Watch this space and get the lowdown on how this all shakes out.