Health Insurance Rebates Could Be Taxable

Post Date: 10/19/12
Last Updated: 10/19/12

Summary

Cross References
• Public Law 111-148, Patient Protection and Affordable Care Act
• www.irs.gov

Beginning January 1, 2011, health insurance companies are required to spend most of the premium dollars on health care, not on profits and overhead (85% in the large group market and 80% in the small group and individual market). The insurance company is required to rebate any excessive overhead to enrollees. The insurance company must file reports that disclose the percentage of premiums they spend on items other than health care costs, such as bureaucracy, marketing, or executive compensation. The money required to be rebated is called medical loss ratio (MLR) rebates.

The first MLR rebates under this rule were required to be disbursed to health insurance policyholders by insurance companies on or before August 1, 2012. Employers that operate self-insured plans are exempt from this rule.

Whether a particular MLR rebate is taxable depends upon a number of variables. Some individuals are receiving their premium rebate checks directly from the health insurance provider. Others are receiving the rebate indirectly from their employers, either as cash payments or in the form of 2012 premium offsets. Some employers are using the rebates to cover plan expenses.

Author's Comment: Even though an employer may receive a rebate check from the insurance company, ERISA rules do not require the employer to directly pass through the rebate to its employees. Employers have some discretion as to how to use or dispose of their rebates, as long as they act prudently, solely in the interest of the plan participants and beneficiaries, and in accordance with the terms of the plan.

Tax consequences of rebates. If a tax benefit was previously gained on the premiums now being refunded, the rebate is taxable. If no tax benefit was gained, the rebates are tax free to the recipient.

For example, if employees make premium contributions with pre-tax dollars through a cafeteria plan, then any rebate is subject to federal income and employment taxes. This is true regardless of whether the rebates are distributed to the employees in the form of cash or a credit or offset against future premiums.

The IRS recently provided guidance on their website to determine specifically when MLR rebates are subject to tax, and when they are not.

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