How To Handle Medical Loss Ratio Benefits and Tax Reductions

MLR Annual Reports

Along with the passing of the Affordable Care Act came a provision to the Medical Loss Ration Requirement. The provision includes that the Public Health Service now requires Health Insurance Companies to submit annual reports and send rebates to enrollees when the spending does not meet minimum standards for a given plan year. 

These reports are to include:

  1. The percentage of premiums spent on reimbursing for clinical services provided to enrollees
  2. The percentage of premiums spent for activities that improve health care quality
  3. The percentage of premiums spent on other non-claims costs excluding taxes and regulatory fees.

Companies can expect to begin receiving rebates from their 2011 plan in 2012.  The question is - what to do when you receive the rebate? 

Basically, there are five scenarios employers must consider.

After Tax Employer Premium Reduction

The first situation is if a company and the employee both pay for the insurance premium, the coverage was after tax dollars and the employee did not claim the premiums on his/her tax return. If this is the case, any rebate would go back as a reduction to the employer for their percentage paid to the carrier. The amount the employee paid would also be a reduction to their premium.  In this situation, there would not be any taxes applied to the employee because the original amount paid was in after tax monies.

After Tax Employee and Employer Receive Cash Rebate

In the scenario above, the rebate was not in cash. Now let’s look at the same example, but this time cash was paid back to the employee and the employer.  In this situation, the employee would still not be taxed due to the fact the original premium withheld from his/her paycheck was in after tax dollars.

Employees Receive Cash Rebate and Deduction on Premium on Form 1040

Looking at another situation where rebates are provided to all employees that participate in a company’s group health plan (after tax) - should an employee receive a rebate and also deducted their premium on Form 1040, again there would not be any taxes on this individual. Instead, this would result in a reduction on the employee’s Form 1040 because this rebate is considered a purchase price adjustment.

Employee’s Premium Held Pre-Tax, Premium Reduction for Employer and Employee

Looking at group polices where a participating employee’s premium is withheld as pretax dollars and the insurer sends sends an MLR, both the employer and employee’s portion of the premium would be a reduction in premium.  Since this is a reduction in the amount of premium paid for the employee and it was deducted as pre-tax, the employee would be taxed on the amount their premiums were reduced.

2011 Plan Year - Employee’s Premium Held Pre-Tax, Premium Reduction for Employer and Employee

If the above scenario was a rebate in 2012 for the 2011 plan year, the employee’s taxable income for 2012 will be increased by the amount of the rebate.

These scenarios are some basic guidelines to follow when making the determination of taxing an employee or not, and if the employee will need to make adjustments to their Form 1040.  The key elements that play a part in the decision is the plan year the premium was withheld in, the year the rebate was sent,  if the insurance was after tax or pretax and if the employee was in a group plan or not and participating or not.  For specifics, the IRS issued Rebate FAQ’s for different the different tax situations.

For more info and tips on payroll related issues, check our payroll blog often.  To lean how Optimum Payroll Software can make your payroll process easier than ever, request a free demo today.

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