IRS Is Eyeing a Loophole in Health Savings Account Rules

Tax Analysts is reporting here that the IRS is aware that Health Savings Accounts (“HSAs”) may constitute a possible source of abuse due to a loophole in the law. Remarks were made to that effect by Kevin Knopf, benefits tax counsel for the Treasury Department at a May 26 Silverstein and Mullens Tax Management Luncheon. The point of concern has to do with this: HSA account holders can spend funds accumulated tax-free solely for medical expenses until the age of 65. However, no one really monitors whether or not the money withdrawn is actually being spent on medical expenses. In other words, there is no requirement that trustees monitor the withdrawal of these moneys or that individuals substantiate their expenses before making withdrawals. Of course, taxpayers are always subject to audit, and agents will likely look into this matter when performing an audit.

Will HSAs be the target of audits in the future? Knopf’s answer is this:

“It’s up to your discretion as professionals whether you think the IRS has the resources to go after thousands and thousands of individuals to ensure that they are using this money solely for medical expenses,” he told the audience.

Blogs in the News. . .

There is a brief critique of Benefitsblog in this article from Law.com–”Feeding Time.” (I will see if I can work on my “cryptic” headlines and my not-so-prominent RSS link button.)

Also, this article from the BBC News.com: “Gates backs blogs for businesses.”

Employers Reducing Benefits and Bracing for Litigation

Chubb Group of Insurance Companies has issued its results in the The Chubb 2004 Private Company Risk Survey. You can access the Fiduciary Liability Survey Results here. According to the survey:

  • Only 5% of the private companies surveyed reported that a retired employee had brought a suit against the company, directors and officers, and/or benefits plan administrators and fiduciaries within the past few years.
  • Almost 1 in 4 executives said that they thought it was likely that such suits would occur this year.
  • Two-thirds of the private firms said that they planned to reduce employee benefits during 2004. (The Survey indicates that employee benefit reductions generally increase the risk of a fiduciary liability lawsuit.)
  • Over a third of the companies appeared to be taking positive steps to ward off the threat of lawsuits against their companies and fiduciaries.

On the employment practices liability side of things, the Survey came up with these findings as reported in the press release:

One in four privately held companies has been sued by an employee or former employee in the past few years . . . Executives at as many as half the firms surveyed say it is likely that an employee may sue them, their board members and their companies and/or lodge a discrimination complaint with federal or state authorities in 2004. And nearly one-third believe that an allegation or actual case of wrongful termination, discrimination or harassment has the potential to inflict financial or other serious damage to their company.

Employers Reducing Benefits and Bracing for Litigation

Chubb Group of Insurance Companies has issued its results in the The Chubb 2004 Private Company Risk Survey. You can access the Fiduciary Liability Survey Results here. According to the survey:

  • Only 5% of the private companies surveyed reported that a retired employee had brought a suit against the company, directors and officers, and/or benefits plan administrators and fiduciaries within the past few years.
  • Almost 1 in 4 executives said that they thought it was likely that such suits would occur this year.
  • Two-thirds of the private firms said that they planned to reduce employee benefits during 2004. (The Survey indicates that employee benefit reductions generally increase the risk of a fiduciary liability lawsuit.)
  • Over a third of the companies appeared to be taking positive steps to ward off the threat of lawsuits against their companies and fiduciaries.

On the employment practices liability side of things, the Survey came up with these findings as reported in the press release:

One in four privately held companies has been sued by an employee or former employee in the past few years . . . Executives at as many as half the firms surveyed say it is likely that an employee may sue them, their board members and their companies and/or lodge a discrimination complaint with federal or state authorities in 2004. And nearly one-third believe that an allegation or actual case of wrongful termination, discrimination or harassment has the potential to inflict financial or other serious damage to their company.

DOL Issues Final COBRA Regulations

Final COBRA Regulations have been issued by the Department of Labor. You can access the Press Release announcing the regulations here and the Model Notices here. Regarding the effective date, the DOL states:

In order to give plans enough time to modify their notice procedures, the new rules will be effective the first plan year that begins six months after publication of the rules in the Federal Register. [The publication date is May 26, 2004.] Before that date, plans may rely on either the proposed rules or the final rules (including the model forms as proposed or as finalized) to meet their COBRA notice obligations.

DOL Issues Final COBRA Regulations

Final COBRA Regulations have been issued by the Department of Labor. You can access the Press Release announcing the regulations here and the Model Notices here. Regarding the effective date, the DOL states:

In order to give plans enough time to modify their notice procedures, the new rules will be effective the first plan year that begins six months after publication of the rules in the Federal Register. [The publication date is May 26, 2004.] Before that date, plans may rely on either the proposed rules or the final rules (including the model forms as proposed or as finalized) to meet their COBRA notice obligations.

Health Savings Accounts and the Barrier of State Mandates

Legislation was passed in Kansas last week allowing health savings accounts to be utilized in that state. Apparently, according to this article, the problem was this: State law mandated that mental and nervous conditions be covered for 100 percent of the first $100 of expenses, 80 percent of the next $100, and 50 percent of the next $1,640. Thus, if an insurance carrier had to provide this first dollar coverage, the plan no longer would meet the federal definition of a “High Deductible Health Plan” (“HDHP”), meaning that health savings accounts could not be utilized in that state. The old Medical Savings Accounts were available in Kansas because the state exempted them from this requirement. The Kansas legislature was quick to remedy the problem by enacting legislation. Good for them.

Other states with similar issues should follow suit, enacting legislation to make HSAs viable in their states. Please note the following language in IRS Notice 2004-23 pertaining to mandated state law requirements:

Section 220(c)(2)(B)(ii) allows a high deductible health plan for purposes of an Archer Medical Savings Account to provide preventive care for this purpose. Section 223(c)(2)(C), for purposes of an HSA, does not condition the exception for preventive care on State law requirements. State insurance laws often require health plans to provide certain health care without regard to a deductible or on terms no less favorable than other care provided by the health plan. The determination of whether health care that is required by State law to be provided by an HDHP without regard to a deductible is “preventive” for purposes of the exception for preventive care under section 223(c)(2)(C) will be based on the standards set forth in this notice and other guidance issued by the IRS, rather than on how that care is characterized by State law.

In other words, the IRS has stated it will not automatically consider state law mandated coverage to be “preventive” under the HSA requirements. As a result, plans that would otherwise be HDHPs could fail to qualify if they provide a state-mandated benefit that must be paid before the high deductible applies, unless that mandated benefit qualifies as “preventive” under the IRS safe harbor definition. The IRS has a whole laundry list of what constitutes “preventive” care in IRS Notice 2004-23 (in the Appendix). They have also asked for comments regarding other items which should be added to the list, indicating that the list may grow in the future.

Tension Between the 'Savings Clause' and the 'Deemer Clause' under ERISA

Russell B. Korobkin of the University of California, Los Angeles – School of Law has written a paper on the use of self-insured plans and the purchase of “stop-loss insurance” to avoid state mandates and insurance risk through the “deemer clause” under 29 U.S.C. section 1144(b)(2)(B) of ERISA: “The Battle Over Self-Insured Health Plans, or ‘One Good Loophole Deserves Another.”‘ The paper suggests that states may through the loophole of the “savings clause” under 29 U.S.C. section 1144(b)(2)(A) of ERISA regulate such arrangements by prohibiting “insurance companies from selling any stop-loss coverage for losses associated with health care costs unless the underlying coverage includes the list of state mandated benefits that state insurance companies must provide.”

Tension Between the 'Savings Clause' and the 'Deemer Clause' under ERISA

Russell B. Korobkin of the University of California, Los Angeles – School of Law has written a paper on the use of self-insured plans and the purchase of “stop-loss insurance” to avoid state mandates and insurance risk through the “deemer clause” under 29 U.S.C. section 1144(b)(2)(B) of ERISA: “The Battle Over Self-Insured Health Plans, or ‘One Good Loophole Deserves Another.”‘ The paper suggests that states may through the loophole of the “savings clause” under 29 U.S.C. section 1144(b)(2)(A) of ERISA regulate such arrangements by prohibiting “insurance companies from selling any stop-loss coverage for losses associated with health care costs unless the underlying coverage includes the list of state mandated benefits that state insurance companies must provide.”

"The Classic Corporate Love Story"

Thanks to the Securities Litigation Watch for the pointer to the opinion issued in this case–GSC Partners CDO Fund v. Washington, (3rd Cir. (N.J.) May 17, 2004) (NO. 03-2347) in which Third Circuit Court of Appeals Judge Richard D. Cudahy provides us with a rendition of the “classic corporate love story”:

The background of this case is the classic corporate love story. Company A meets Company B. They are attracted to each other and after a brief courtship, they merge. Investor C, hoping that the two companies will be fruitful and multiply, agrees to pay $50 million for the wedding. Nine months later, however, things begin to fall apart and the combined entity declares bankruptcy. Investor C feels misled. He believes that Company A knew that there were problems with Company B but that it made the oft repeated mistake of thinking that it would be able to change Company B for the better. Investor C files suit in the district court and after his complaint is dismissed, we find ourselves here. It is an old story but it never fails to elicit a tear.