One way to cut down on your tax liability is to put money into a flexible spending account (FSA). This tax-free money can be used to cover certain medical expenses.
Come 2018, employers may be less likely to offer that benefit.
That’s when the high-cost plan tax, or Cadillac tax, a provision of the Affordable Care Act (ACA), kicks in.
The tax applies to employer-sponsored health plans that exceed $10,200 for a single person or $27,500 for family plans. After 2018, these amounts will increase with inflation.
The tax will be 40 percent of the difference between the total cost of health benefits for an employee in that year and the threshold amount for that year.
For big employers, that adds up to big money.
A report from The Kaiser Family Foundation suggests that about 19 percent of employers currently have a plan that would exceed the threshold when FSAs are factored in.
In future years, as inflation and health insurance premiums rise, more firms are likely to be affected.
Laura T. Kerekes, chief knowledge officer at ThinkHR.com, told Healthline that the tax targets generous employer-provided healthcare plans. She believes it will heavily impact industries where unions have negotiated richer health benefits in lieu of higher wages.
The only way for employers to avoid the tax is to keep health costs below the threshold. One way to do that is to stop offering FSAs.
How Flexible Spending Accounts Work
FSAs are only available through an employer. It’s a way for employees to set aside a portion of their compensation for medical expenses.
Employees decide on the amount and make the deposits, but employers can also contribute. Deposits are capped at $2,550 per year for 2015.
The money can only be used for qualified medical expenses within the plan year. This includes deductibles and copayments but not insurance premiums.
Employers don’t have to, but they can choose to allow up to $500 to be carried over into the next year. Alternatively, employers can offer a grace period of up to two and a half months to spend leftover FSA funds. They can’t do both.
There are some tax advantages for employers, and employees don’t have to pay income tax on the money.
Avoiding the Cadillac Tax
Hector De La Torre, executive director of the Transamerica Center for Health Studies, said it’s important to note that the exact formulas for calculating the tax have not yet been released by the IRS.
Even so, employers are already seeking ways to avoid the tax. Not that it’s simple.
“Employers should review each of their plan offerings and every contribution they make to employee health to determine their exposure. Even if only one of their offerings is over the threshold, the tax will be due,” De La Torre told Healthline.
He said multistate employers must also consider geographic differences. They need to look at plans in all regions in which they operate.
Kerekes said it’s likely that all employer-sponsored group health plans will be included, but that stand-alone dental and vision plans would not. Employer and employee contributions to FSAs are also expected to be included.
Besides capping or eliminating FSAs, Kerekes said employers may also consider eliminating health insurance options for premium or higher cost plans.
They may also use less expensive provider networks, reduce covered services, and increase deductibles and cost sharing.
What Happens if the Cadillac Tax Is Repealed?
Opponents of the tax are talking repeal, but there’s a lot to consider.
“If the Cadillac tax is eliminated and the trend continues shifting to employees funding more of the costs of their healthcare, it will remain to be seen if that will actually reduce healthcare costs in the long run,” Kerekes said.
“Our government will also need to determine how to make up for the shortfall with no Cadillac tax revenue to pay for the government-mandated ACA-related expenses,” she added.
Michael Morrisey, Ph.D., is department head and professor of health policy and management at the Texas A&M School of Public Health.
He told Healthline that the Cadillac tax is one of the few components of the ACA that is actually likely to lead to reduced healthcare spending.
“The argument is that if we have to pay more out of pocket because our insurance hasn’t yet kicked in, we will consume less healthcare. Common sense and some pretty good research supports that view,” he said. “The tax, however, does generate a lot of revenue. One estimate I’ve seen suggests that the tax would generate something like $931 billion in tax revenue between 2020 and 2029.”
Morrisey added, “It’s numbers like that that make it hard for Congress to find alternative budget savings. Eliminating the Cadillac tax does mean that healthcare costs will rise more rapidly than they otherwise would have.”
Morrisey said the tax would affect the nature of employee compensation.
“Expect firms to eliminate FSAs and increase deductibles,” he said. “Some will increase wages to compensate for these reductions, but employees will have to pay taxes on those higher wages.”