IRS’ New Audit Guidelines Adds to COBRA’s Bite
The IRS first established a task force to develop audit guidelines for enforcement of the COBRA rules in 1993. These were updated in 2002, and now, a decade later, the IRS has issued new COBRA audit guidelines (Guidelines). A quick reading of the Guidelines clearly indicates that the IRS will be looking at COBRA compliance with a new level of seriousness and scrutiny. The second half of the Guidelines provides a succinct, readable, yet detailed overview of the COBRA requirements. Employers, insurers, third party administrators (TPAs) or other businesses that manage or administer COBRA programs should find it a useful compliance tool. The Guidelines can be found at: http://www.irs.gov/.
Recently, the Department of Labor (DOL) also has been increasing its examination of plans for COBRA compliance. The IRS appears to be readying for a similar increase in COBRA audits. Sponsors of group health plans subject to COBRA, insurers of those plans, TPAs who administer those plans, and any other companies that provide COBRA administrative services will all need to review and examine their documentation and administrative practices, as the penalties for non-compliance can be severe (see below), and the odds of having operational and documentary failures discovered are likely to increase.
The new COBRA audit procedures will require examiners to review the following documents:
- The employer’s COBRA procedures manual,
- The standard COBRA letters sent to qualified beneficiaries,
- The internal audit procedures for ensuring that COBRA is being properly implemented,
- Copies of all health care plan documents, and
- Details about any past or pending lawsuits filed alleging failure to provide appropriate COBRA coverage.
These five documents will be requested on every COBRA audit.
Other documents that the Guidelines tell examiners might provide useful information are:
- Federal and state employment tax returns filed during the period of examination and the preceding year as these will show changes in the number of employees on the payroll between the two years,
- Lists of all individuals affected by a qualifying event (e.g., terminations, lay-offs, etc.),
- Lists of all individuals covered during the current and preceding years for each health care plan, and
- Personnel records to determine whether qualified beneficiaries were notified of their COBRA rights.
According to the Guidelines, personnel files should have the following information: (i) the names and address of every covered individual, (ii) date and description of the qualifying event, and if a termination of employment, the reasons for the termination, (iii) copies of the COBRA notices sent to qualified beneficiaries, (iv) type of COBRA coverage elected, (v) amount of premium payments required, (vi) if applicable, letter(s) from the employer to the insurer or TPA notifying them of a qualifying event, and (vii) if applicable, reasons why COBRA coverage was terminated.
Having reviewed the relevant documents, the examiner is then instructed to probe specific areas for noncompliance by interviewing “responsible” individuals about:
- The number of qualifying events during the period under examination,
- The method by which qualified beneficiaries are notified of their COBRA rights and rights to elect COBRA,
- The method by which the plan administrator is notified of a qualifying event,
- Elections of COBRA coverage during the period under examination, and
- The premium paid for COBRA coverage and the method for determining the premium amount.
Excise Tax and Other Penalties
The excise tax imposed for COBRA violations is $100 per qualified beneficiary (but not more than $200 per family) for each day the taxpayer is in violation – i.e., the noncompliance period. The noncompliance period begins on the day the failure occurs and ends on the date the failure is corrected.
A failure is considered corrected if: (i) the rules are retroactively satisfied to the extent possible, and (ii) the qualified beneficiary is placed in a financial position that is as good as he or she would have been in had the failure not occurred.
For unintentional failures due to reasonable cause and not to willful neglect, the penalties are capped at:
- For single employer plans, the lesser of 10% of the amount paid or incurred by the employer for its group health plan during the preceding tax year, or $500,000,
- For multiemployer plans, the lesser of 10% of the amount paid to provide medical care during the preceding tax year, or $500,000, and
- For third parties such as insurers, TPAs or other independent COBRA administrators, $2 million.
COBRA excise taxes are to be self-reported on IRS Form 8928.
Note: If the employer or other person liable for the tax becomes aware of the failure and makes no effort to correct it, a failure that may not have initially been attributable to willful neglect becomes attributable to willful neglect.
No excise tax will be imposed if:
- It can be established to the satisfaction of the IRS that none of the persons who would be liable for the tax knew, or with reasonable diligence would have known, that the failure existed.
- The failure is due to reasonable cause and not willful neglect and the failure is corrected within 30 days of its being discovered or the date it would have been discovered upon the exercise of reasonable diligence.
If a COBRA failure is not corrected before the date of an IRS notice of examination, the minimum amount of the excise tax is $2,500 for each qualified beneficiary for whom one or more failures occurred, if the failures were, in the view of the examiner, de minimus, and $15,000 for each qualified beneficiary, if deemed to be more than de minimus. There may also be additional penalties imposed for interest, tax understatements and for failure to timely report the excise taxes on Form 8928.
With respect to a failure due to reasonable cause and not willful neglect, the Secretary can waive part or all of the excise tax to the extent he deems it unreasonably burdensome. Among the factors considered in this determination are:
- The quality of the COBRA compliance program in place at the time,
- The training of the individuals responsible for operational compliance,
- The written instruction and other materials given to those individuals, and
- The extent to which the compliance program was developed based on competent legal and actuarial advice.
It should be kept in mind, however, that IRS excise taxes are not the only penalties for COBRA failures. Under ERISA, failure to timely provide a COBRA notice is subject to civil penalties of up to $110 per day, plus attorneys’ fees. The aggrieved individual may also be able to recover benefits that he or she would have had if COBRA had been properly administered, and since electing COBRA is a classic example of adverse selection, this could amount to a significant expense for self-funded employer plans. Employers with insured plans may find that the insurer will not cover benefits available because COBRA was not properly administered, and so the employer may end up self-funding benefits it thought were insured.
Lawsuits over COBRA coverage are very common, as those who are denied such coverage usually have a major need for health care coverage, thus giving them a reason to pursue litigation, even if it seems a long shot. Thus, even if the employer, insurer or TPA ultimately prevails, COBRA litigation will prove expensive, especially in those cases where the procedures are poorly documented and/or haphazardly followed, so the case cannot be won on summary judgment and must go to trial.
In light of these stricter COBRA audit guidelines, employers with plans subject to COBRA, their insurers, TPAs, or other COBRA administrators should: (i) review for accuracy and completeness how COBRA coverage is described in the plan document(s) and summary plan description(s), (ii) review whatever written policies and procedures it or they may have to assess if these would be adequate as a “COBRA procedures manual,” and if not, what needs to be done to make them complete enough that they might so qualify, (iii) review and assess the training program for employees who administer COBRA, (iv) review and revise any applicable COBRA administrative services agreement with an eye towards ensuring that the responsibilities are appropriately allocated, are adequate to pass muster under these expanded Guidelines and appropriately address indemnification issues.
If you have any questions about how best to prepare for, or respond to, these stricter COBRA audit Guidelines, any related aspects of COBRA administration, or any other employee benefit concerns, please contact one of the Employee Benefits attorneys.