Companies routinely continue the health plan coverage of certain terminated executives. However, an often overlooked fact is that Code Sec. 105(h) prohibits self-insured health plans (which nearly every employer in America with more than 100 employees maintains) from discriminating in favor of highly compensated individuals as to eligibility to participate or benefits provided. For purposes of Sec. 105(h), the term "highly compensated individual" means an individual who is (a) one of the five highest paid officers, (b) a 10% of more shareholder, or (c) among the highest paid 25% of all employees.
Therefore, companies that provide continuing coverage to executives who retire or otherwise terminate employment, but not to other employees, could be violating Code Sec. 105(h), and the former executives receiving this continuing subsidized coverage could be at risk for the IRS treating that coverage or the treatment provided as taxable ordinary income.
To date, the non-discrimination requirements have not applied to fully insured health plans. However, a change under the Patient Protection and Affordable Care Act of 2010 would subject an employer to daily penalty taxes if it offers post-termination health benefits to executives only (i.e., on a discriminatory basis). Ironically, the penalty tax applies to insured plans and not to self-insured plans. Apparently, Sec. 105(h) still applies to self-insured plan. However, like so many aspect of the Affordable Care Act, this is all very murky.
We are waiting for regulations on fully-insured health plans that may be discriminatory and clarification on how the new rule integrates with Code Sec. 105(h). Until our government provides us with this guidance, employers should tread carefully.
This entry has been created for information and planning purposes. It is not intended to be, nor should it be, substituted for legal advice, which turns on specific facts.