On February 17, 2009, President Obama signed the American Recovery and Reinvestment Act of 2009 (ARRA). One of the provisions of ARRA establishes a new set of rules under which an “Assistance Eligible Individual” must be offered the opportunity to pay reduced COBRA premiums for group health coverage on and after February 17, 2009 for a period of up to nine months. More specifically, Assistance Eligible Individuals will only need to pay 35 percent of the full COBRA premium otherwise due to the plan and the employer may recover the remaining 65 percent of the premium by taking the aggregate subsidy amount as a credit on its quarterly employment tax return.

The language in ARRA did not provide sufficient guidance as to the application of the reduced COBRA premiums. However, since the enactment of ARRA, both the US Department of Labor and the Internal Revenue Service have issued guidance which collectively creates a helpful roadmap for the implementation of the new COBRA rules.

The following is not intended to be an exhaustive review of the new rules, but rather a high level series of frequently asked questions about the new rules.

1.         Who is an Assistance Eligible Individual? 

An Assistance Eligible Individual is an individual (a) who is a qualified beneficiary as a result of a covered employee’s involuntary termination of employment (for reasons other than gross misconduct) which occurs at any time from September 1, 2008 and through December 31, 2009, (b) who is eligible for COBRA at any time from September 1, 2008 through December 31, 2009, and (c) who elects COBRA coverage.

Significantly, all of the above requirements must be met. Accordingly, an individual who is involuntarily terminated prior to September 1, 2008 and who loses coverage on or after September 1, 2008 but before December 31, 2009 is not an Assistance Eligible Individual.  Similarly, an individual who is involuntarily terminated on December 25, 2009 but who does not lose group health coverage until January 1, 2010 is not an Assistance Eligible Individual.

2.         For purposes of identifying an Assistance Eligible Individual, how is the term “involuntary termination” defined?

Under recently released IRS Notice 2009-27, the IRS addresses the definition of “involuntary termination” in a set of nine questions and answers. Generally, an involuntary termination means a “severance from employment due to the independent exercise of the unilateral authority of the employer to terminate the employment” where the employee was otherwise “willing and able to continue performing services.” Moreover, the IRS has interpreted the concept of “involuntary termination” to include situations where the employee chooses to quit if the quit is due to an employer action that causes “a material negative change in the employment relationship for the employee.”

The Notice provides some helpful examples, which include but are not limited to the following:

A termination elected by an employee in return for a severance package where the employer indicates that after the offer period for the severance package, a number of remaining employees in the employee’s group will be terminated.

A retirement elected by the employee if the facts indicate that the employee knew that his/her employment would have been terminated had retirement not been elected.

A quit for good reason (e.g. a material change in the geographic location of employment).

On the other hand, a reduction in hours which results in a loss of health care coverage will not cause an employee to become an Assistance Eligible Individual even though regular COBRA rights are triggered. However, if the reduction in hours can be characterized as a “material negative change in the employment relationship” and the employee subsequently quits in response to the reduction in hours, the employee will then become an Assistance Eligible Individual.

3.         How long does the COBRA subsidy continue?

The subsidy is for a period of nine months. The nine-month period can be shortened under a variety of circumstances including but not limited to nonpayment of the required premium and eligibility for coverage under another major medical group health plan. Note that qualified beneficiaries receiving the COBRA subsidy are required to notify the employer if they become eligible for other group health coverage. Failure to provide such notification will subject the qualified beneficiary to a penalty of 110 percent of the subsidy amount.

4.         Can an employer pay the Assistance Eligible Individual’s 35 percent share of the premium and still claim the 65 percent subsidy of the premium as a tax credit?

No. According to the IRS, the 35 percent share of the premium otherwise owed to the plan cannot be paid by the employer.

5.         Is the subsidy retroactive to September 1, 2008?

No. The earliest period to which the subsidy applies is the first period of coverage commencing on and after February 17, 2009 (the enactment date of ARRA). 

6.         When does the nine-month period for the COBRA subsidy begin and when does it end?

The nine-month period for the COBRA subsidy begins as of the first period of group health coverage commencing on or after February 17, 2009 for which an individual qualifies as an Assistance Eligible Individual. The exact date on which the first period of coverage begins depends upon the period for which premiums are charged under the group health plan. If the premiums are charged on a monthly basis, the first period of coverage on or after February 17, 2009 is the period beginning on March 1, 2009. In this case, the subsidy only applies to the COBRA premiums for March 2009 and subsequent months within the nine-month period.

The premium reduction period ends upon the first to occur of (a) the first date the individual becomes eligible for other group health coverage, (b) the date that is nine months after the first day of the month for which the reduced level of premiums are applied to the individual, or (c) the date the individual ceases to be eligible for COBRA continuation coverage.

7.         What is the definition of “COBRA premium” for purposes of the subsidy?

The 65 percent subsidy applies to the COBRA premium otherwise due to the group health plan. For example, if the COBRA premium is $200 per month and if the Assistance Eligible Individual is otherwise responsible for the full premium, then the Assistance Eligible Individual will owe $70 (35 percent of $200) per month and the remaining $130 (65 percent of $200) will be covered by the employer. The employer will be eligible for a tax credit in the amount of $130 on its quarterly tax return (Form 941).

By way of a second example applying the above rule, assume that the COBRA premium is $200 per month, but that the employer, as part of a severance package, has agreed to pay 80 percent of the Assistance Eligible Individual’s COBRA premium for three months. In this case and during the first three months, the employer will pay $160 (80 percent of $200) per month plus a subsidy of 65 percent of the remaining $40 per month or $26. The Assistance Eligible Individual will be responsible for $14 of the $40 premium.

8.         Has the government prepared a model notice?

Yes. The Department of Labor has provided four model notices. The notices are located at the Department of Labor’s Web site located at http://www.dol.gov/ebsa/COBRA.html. The model notices are not intended to be duplicative and are targeted at the following individuals:

            (i)         Full Version/General Notice (sent by plans subject to Federal COBRA): Send to all qualified beneficiaries (a) who experienced a qualifying event at any time from September 1, 2008 through December 31, 2009, regardless of the type of qualifying event AND (b) who either (1) have not yet been provided an election notice or (2) were provided an election notice on or after February 17, 2009 that did not include the additional information required by ARRA.

            (ii)        Abbreviated Version/General Notice (sent by plans subject to Federal COBRA):  Send to all qualified beneficiaries (a) who experience a qualifying event on or after September 1, 2008, (b) who have already elected COBRA coverage, and (c) who still have COBRA coverage.

            (iii)       Alternate Notice (sent by insurers): Send to individuals who are eligible for continuation coverage under state law.

            (vi)       Notice in Connection with Extended Election Periods (sent by plans subject to Federal COBRA): Send to any Assistance Eligible Individual (or any individual who would be an Assistance Eligible Individual if a COBRA election were in effect, who (a) had a qualifying event at any time from September 1, 2008 through February 16, 2009 AND (b) who either (1) did not elect COBRA coverage or (2) elected COBRA coverage but subsequently discontinued COBRA.

9.         Are there income limits associated with eligibility for the COBRA subsidy?

If an individual’s adjusted gross income for the tax year in which the premium is received is less than or equal to $125,000 (or less than or equal to $250,000 in the case of those filing joint returns), there is no federal tax on the COBRA subsidy. If an individual’s adjusted gross income for the tax year in which the premium is received exceeds $145,000 (or exceeds $290,000 for those filing joint returns), the full amount of the subsidy will be treated as taxable income. For individuals having adjusted gross income in excess of $125,000 but not in excess of $145,000 (or in excess of $250,000 but not in excess of $290,000 in the case of joint filers) for the tax year in which the premium is received, there is a proportional phase-out of the subsidy.

Individuals who earn above the amounts listed above may waive their rights to the premium reduction; however, the waiver is irrevocable, even if the individual’s adjusted gross income later drops below $125,000. For example, an Assistance Eligible Individual becomes eligible for COBRA on October 1, 2009. The Assistance Eligible Individual believes that his adjusted gross income in 2009 will exceed $145,000 and he waives his right to nine months of premium reduction. (If he had not waived the right to a premium reduction, he would have received three months of subsidized coverage in 2009 and six months of subsidized coverage in 2010.)  However, in 2010, his adjusted gross income will be under $125,000.  Since he waived the subsidy in 2009, he will not be eligible for the remaining six months of subsidization in 2010.

10.  How does the employer claim the tax credit?

An employer claiming reimbursement of the 65 percent share of the subsidy should use recently revised Form 941. Significantly, the due date (April 30, 2009) for the first quarter 2009 Form 941 is not being extended. 

While no additional information relating to the COBRA subsidy is submitted with the Form 941, employers must maintain supporting documentation for the credit claimed, including but not limited to attestation of involuntary termination which reflects the dates of such termination for each covered employee whose termination is the basis for the subsidy.

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.