On August 27, 2013, the 2014 Affordable Care Act health care reforms moved an important step closer to reality with the issuance of final Internal Revenue Service regulations on the ACA’s shared responsibility for maintaining minimum essential coverage requirement, popularly known as the individual mandate. The IRS also released a fact sheet on the rule, and had earlier released a set of questions and answers on the provision.

The purposes of the individual responsibility requirement

The shared responsibility provision requires individuals who do not qualify for an exemption to maintain “minimum essential” health insurance coverage (MEC) or pay a penalty.  The shared responsibility requirement serves two purposes.  First, it is intended to encourage individuals to be responsible for ensuring payment for their own health care rather than depending on “free” uncompensated care from providers.  Second, it is intended to stabilize health insurance risk pools by increasing participation by healthy individuals given the fact that guaranteed issue, modified community rating, and the end of preexisting condition requirements will draw less healthy individuals into the market.

Although the requirement has proven intensely controversial, it was upheld by the Supreme Court as constitutional in National Federation of Independent Business v. Sebelius.  Unlike the employer mandate, which is primarily intended to discourage the erosion of employer coverage over the long term, the individual responsibility provision is necessary from the beginning in 2014 to make the insurance market reforms work.  Also, unlike the employer mandate, whose penalties would have been fully in effect in 2014, the individual responsibility penalties will already be phased in over three years, with the minimal penalties of the first year intended primarily for educational purposes.  It makes no sense, therefore, to put off the mandate, and the issuance of the final rule should put an end to speculation that the IRS might delay it.

Issues the regulation addresses

The final rule addresses the major issues raised by the individual responsibility requirement:  Who is responsible for coverage?  What is minimum coverage?  Who qualifies for exemptions?  How much are the penalties?  How will they be administered?

Most of these issues are addressed in some detail in the statute itself. Moreover, the  exchanges under the oversight of the Department of Health and Human Services are responsible for determining eligibility for a number of the individual responsibility requirement exemptions (in particular, a number of hardship exemptions) as well as for deciding if individuals have MEC for purposes of eligibility for premium tax credits.  HHS issued a final rule on MEC and on several of the mandate exemptions on July 1, 2013, which I blogged about here.  HHS also released a guidance explaining the hardship provisions of its rule.

The IRS rule cleans up some of the details still left open by the HHS rule, although it also leaves a number of details open for future guidance.

Whom does the rule cover?

Throughout the IRS rule uses the term “taxpayer” to refer to the individual who is responsible for ensuring MEC for him or herself and dependents.  That term will be used in this blog post, even though the responsible individual may or may not in fact end up owing any taxes.

A nonexempt taxpayer must maintain MEC for each month of a taxable year or pay a penalty for that month.  The final rule clarifies that a taxpayer has MEC for any month in which the taxpayer has MEC for at least one day of the month.  In most instances, if a taxpayer has coverage for one day in a month the coverage lasts for the entire month; for the few cases where this was not true, the IRS did not want to have to figure how many days of coverage were sufficient.  The IRS promises to keep an eye on developments, however, to determine if the rule is being abused.

A taxpayer is responsible for ensuring minimum coverage not only for him or herself but also for any persons who qualify as the taxpayer’s dependents under the Internal Revenue Code.  This applies whether or not the taxpayer actually claims the dependent for the taxable year, although if more than one taxpayer can claim a dependent, the taxpayer who in fact claims the dependent is responsible for ensuring that the dependent has MEC.  A taxpayer’s responsibility for a dependent applies whether or not the dependent is covered by the taxpayer’s health insurance plan and also with respect to a taxpayer’s “qualifying relatives,” such as parents or siblings supported by the taxpayer.

If a child is the legal dependent of a custodial parent, the custodial parent is responsible for ensuring the child has MEC even though a non-custodial parent is legally responsible for the child’s health insurance under a divorce or separation agreement or order. Under HHS guidance, however, a custodial parent in this situation may qualify for a hardship exemption if the child is not eligible for Medicaid or CHIP coverage.

A taxpayer who adopts a child is responsible for ensuring the child has MEC for the month following the adoption and all subsequent months.  A taxpayer who places a child for adoption or foster care is only responsible for months preceding the adoption or placement.  Married taxpayers who file a joint return are jointly responsible for any individual responsibility payments.

The definitions in the IRS rule are the same as the definitions found in the HHS rules, many of which come out of the Public Health Services Act.  Household income includes the modified adjusted gross income (MAGI) of the taxpayer plus the MAGI of any members of the taxpayer’s family who are required to file a tax return.  Presumably, if children have income that is below the filing limit, it is not counted as part of household income.

What is minimum essential coverage?

MEC includes government-sponsored coverage, an employer-sponsored plan, individual coverage, grandfathered coverage, and other coverage expressly defined as MEC.  Virtually all Americans over age 65 will be protected from the penalty because they have MEC coverage in Medicare.  A number of government programs do not provide full coverage for medical expenses, and thus do not qualify as MEC.  State Medicaid programs that only provide pregnancy-related services for some pregnant women would not qualify, for example.  Neither do state Medicaid programs that only cover family planning services, tuberculosis-related services, or emergency medical conditions. T

The IRS intends to issue transition guidance excusing pregnant women with pregnancy-only coverage from the penalty for months that they are covered in 2014, however.  HHS intends to issue rules on when coverage under state 1115 waiver programs will be considered MEC, with transition guidance again to excuse covered persons from the penalty for months of coverage in 2014.

Full Medicaid assistance provided through Medicaid premium assistance programs and various Medicaid programs for disabled children and for home and community-based services is considered MEC.  Medicaid coverage for the medically needy is problematic because spend down requirements can result in frequent eligibility changes and coverage can be less than comprehensive.  HHS will issue regulations on the medically needy by January 1, 2014, but the medically needy will not be subject to the penalty for months in which they are covered in 2014.  Future guidance will also address the extent to which limited benefit TRICARE programs are not MEC, again with transition protection from penalties for 2014 for those determined not to have coverage.

Not surprisingly, employer-sponsored coverage is defined in the final rule to include self-insured coverage.  Any employer-sponsored coverage qualifies, including presumably “skinny benefit” plans that do not meet the 60 percent minimum value standard (although an employer would be penalized for each employee who receives premium tax credits because such coverage is inadequate).  IRS guidance issued earlier also excuses employees from having to enroll in employer plans for years that begin prior to 2014, even though those plans extend into months in 2014.

Retiree coverage qualifies as MEC, although an employee who chooses not to accept retiree coverage can apply for premium tax credits instead if he or she is otherwise qualified.  Plans offered on behalf of employers by multiemployer plans, single-employer collectively bargained plans, professional employee organizations or leasing companies, and plans offered by the Nonappropriated Fund Health Benefits Program qualify as employer coverage.  The final regulations reserve for future guidance the question of whether arrangements in which employers provide pre-tax dollars to employees to purchase coverage in the individual market qualify as MEC, even though earlier guidance seemed to eliminate these arrangements.

The final rule clarifies that qualified health plan coverage is individual coverage and thus MEC.  Excepted benefits are not.  Excepted benefits include fixed dollar indemnity plans, which some insurers had been marketing as mini-med replacements.  Of course, fixed dollar income-replacement plans that supplement medical plans can continue to be offered, but they are not MEC.

Taxpayers who are bona fide residents of United States territories are considered to have MEC, as are U.S. citizens who have tax homes outside the U.S. and are bona fide residents of another country for the entire year or for at least 330 full days during a one year period.  Coverage provided by a foreign insurer to a U.S. citizen who does not qualify for one of these exceptions is not MEC.  Neither is expatriate coverage offered to citizens of other countries residing in the U.S., although HHS provides a procedure under which an insurer may apply for recognition as MEC.

Coverage provided by insurers located in the territories is not MEC unless it is offered through an exchange created by a territory. At this point none of the territories has established an exchange.

Who is exempt from the responsibility requirement?

The rule next deals with exemptions.  The religious conscience exemption applies narrowly to members of religious groups such as the Amish that have historically objected to all forms of insurance, and who hold the beliefs of their group.  Eligibility for the religious conscience exemption is determined by the exchanges.  The exemption applies both to taxpayers and their children.  Once a child reaches age 21 the child must reapply individually.  Taxpayers who claim the health care sharing ministry exemption must prove membership for every month of the year.

Individuals not lawfully present in the United States are exempt.  The regulations do not specify how an individual proves unlawful presence, leaving that for guidance.  The prospect of an individual offering proof of illegal status to avoid the mandate is a bit mind-bending, but the IRS will provide a form for it apparently.   Individuals who are incarcerated after final disposition of charges are exempt.

Individuals who are incarcerated pending final disposition of charges for whom Medicaid has been suspended are considered to have MEC since they are still enrolled in Medicaid.

The most common exemption will be that for taxpayers who cannot afford coverage. A taxpayer cannot afford coverage if he or she cannot purchase an eligible plan for eight percent or less of modified adjusted household income (adjusted after 2013 if premium growth exceeds income growth) after employer contributions or premium tax credits are taken into account.  The regulation also specifies that household income will be increased for any amount of the premium paid for through a salary reduction agreement excluded from gross income.

When is coverage not affordable?

A taxpayer whose income is too low to afford health insurance early in a year, but whose income increases so that in the end insurance is affordable may be liable for the penalty if no other exemption applies.  A taxpayer may, however, apply for a hardship exemption prospectively if it appears that health insurance is unaffordable, which will protect the taxpayer against subsequent penalties for months in which coverage was unaffordable even if it turns out that coverage was affordable considering the entire year’s income.

An employee or related individual is considered to be eligible for coverage in an employer-sponsored plan for a month if that individual could have enrolled in that plan for any day in of that month during an open or special enrollment period.  An employee eligible for coverage through that employee’s employer is not treated as a related individual for coverage under another plan (such as a spouse’s plan) that might have offered coverage to that individual.  A former employee or relative who may apply for continuation coverage (such as COBRA coverage) or retiree coverage is eligible for employer-sponsored coverage only if the employee in fact enrolls.

An employee eligible to purchase employer-sponsored coverage is exempt from the requirement if the lowest cost self-only plan offered by the employer costs more than eight percent of household income.  Dependents of an employee for whom a personal exemption is claimed by the employee are exempt if the annual premium of the lowest cost family coverage that would cover the employee and all related individuals is unaffordable.  Note that this rule is different than the rule that applies for determining eligibility for premium tax credits, where coverage for the family is considered to be affordable — and thus the family is ineligible for premium tax credits- — as long as self-only coverage is affordable, even if family coverage is not.  Curiously, the IRS regulations apply different rules to these two situations even though the premium tax credit provision defines affordability by referring to the individual responsibility provision.

If employer-sponsored coverage covers only part of a year, or if the cost of employer-sponsored coverage changes from one part of the year to the next (because, for example, coverage is based on a fiscal rather than calendar year), affordability for each part of the year is determined considering the annualized cost of coverage for each part of the year compared to annual household MAGI.  Thus, coverage may be affordable for some months but not for others.  Employer contributions toward the payment of premiums through an integrated health reimbursement arrangement are probably going to be counted toward the employee’s required contribution, but the issue is left open for future rulemaking or guidance.  The role of wellness incentives in considering affordability is also left open.

If an employee or related person is determined exempt because employer coverage is unaffordable, the employee or related person is exempt from the individual responsibility provision regardless of the fact that individual coverage may have been affordable to the employee or a related person through the exchange using premium tax credits.

If a taxpayer is determined ineligible for employer coverage, affordability is determined based on the cost of the lowest cost bronze (60 percent actuarial value) plan available through the exchange in the taxpayer’s rating area that would cover all individuals in the taxpayer’s family who do not have employer coverage and who are not exempt from the requirement after premium tax credits are applied.  If no one plan would cover all family members, the applicable premium is the sum of the premiums of all plans needed to cover the entire family.  Obviously age rating will apply, and older individuals are more likely to be exempt from the mandate than younger people because of age rating

If tobacco surcharges are applied to the taxpayer or dependents, affordability is determined after the surcharge is applied.  Future guidance will determine the treatment of wellness incentives, but it is anticipated that affordability will be determined without regard to potential wellness discounts.  If some members of a family are eligible for government-sponsored coverage (such as CHIP), affordability will be calculated based on the affordability of coverage to the remaining members of the family, but if coverage is not affordable to the remaining family members, the entire family is exempt.

Taxpayers whose family income falls below the tax filing threshold are exempt from the responsibility requirement.  Obviously, they do not need to file a return to claim that they do not have to file a return.  But if a taxpayer under this exemption does file a return, it does not affect eligibility for this exemption.

Members of federally recognized Indian tribes are exempt.  Other Native Americans eligible for Indian Health Care Services can claim a hardship exemption through the exchange, but cannot claim an exemption on their tax return if they fail to do so.  In general, taxpayers must file for hardship exemptions through the exchange, but the rule recognizes a couple of situations where the information needed to file for the exemption is not available until filing time, and where the hardship can be claimed on the tax return.

The short coverage gap exemption

Taxpayers are eligible for an exemption if they are without coverage for a continuous period of less than three months.  For calculating this period, a taxpayer is treated as not being in a gap between periods of minimum coverage if the taxpayer is otherwise exempt from the requirement.  If there is more than one period of lack of coverage in a single year, the coverage gap exemption only applies to the first period of lack of coverage.

If a period of continuous lack of coverage straddles two years, the months in the second year are not considered in determining if the taxpayer lacked coverage for less than three months in the first year, but the months of noncoverage in the first year are considered in determining whether the taxpayer lacked coverage for three months or more in the second year.

If a taxpayer has coverage for one day or more in a calendar month, that month is not considered in determining whether there has been a gap in coverage.  Months preceding January 1, 2014 are not considered in determining whether there has been a gap in coverage.  A taxpayer who lacks coverage because of a probationary period or while awaiting a determination of Medicaid coverage that is not subsequently applied retroactively is considered to not have MEC, but may be eligible for a hardship exemption.

How much is the penalty and how will it be collected?

The rule repeats the statutory formula for calculating the penalty, based on the greater of either a flat dollar amount or a percentage of income above the filing limit up to the national average cost of a bronze plan that would cover the nonexempt members of the taxpayer’s family.  The flat dollar amounts phase in over three years from $95 in 2014 to $695 in 2016 for the taxpayer and other adults in the taxpayer’s household and half that amount for children up to a maximum of three times that amount for an entire family. The income percentage increases from 1 percent in 2014 to 2.5 percent for years after 2015.

Taxpayers will not be penalized for under-withholding or underpaying estimated taxes because of the application of the shared responsibility penalties.  A taxpayer must report shared responsibility obligations on the taxpayer’s tax return. A taxpayer that fails to pay the penalty is not subject to criminal penalties or to liens and levies, but the IRS can collect the penalty by offsetting it against refunds due the taxpayer for overpayments.