Issues for Employers Implementing the New COBRA Subsidy

Employee Benefits Alert


The American Recovery and Reinvestment Act (“ARRA”), signed by President Obama on February 17, 2009, provided a federal subsidy of 65 percent of the COBRA premiums for individuals who were involuntarily terminated from employment between September 1, 2008, and December 31, 2009. The COBRA subsidy took effect for most plans on March 1, 2009, and is available for a maximum of nine months. To claim the subsidy, an eligible individual simply remits payment of 35 percent of the amount that he or she would otherwise pay for COBRA coverage, and the responsible entity recovers the additional 65 percent via a refundable payroll tax credit. As described below, employers will be responsible entities for plans subject to federal COBRA.

The Department of Treasury, Internal Revenue Service (“IRS”), Department of Labor (“DOL”), and the Centers for Medicare and Medicaid Services (“CMS”) all have been working to issue subsidy guidance. In the interim, agency personnel have been providing their informal reactions. However, employers are advised to use caution before relying on these informal interpretations as there have been many examples where the advice has differed either between agencies or from one week to the next. The following guidance is currently available:

  • The IRS has revised Form 941 and posted general questions and answers;
  • DOL has posted model notices and questions and answers at;
  • CMS has posted information about state continuation laws; and
  • Treasury has issued Notice 2009-27, which includes 58 questions and answers.

More guidance is expected on a number of issues. The following is a summary of the key ARRA subsidy provisions:

Responsible Entities

The following entities are responsible for subsidizing coverage and, therefore, will be eligible for the payroll tax credit:

  • For multiemployer plans, the plan is the responsible entity;
  • For employers subject to federal COBRA (under the Internal Revenue Code, ERISA, or the Public Health Service Act), the employer is the responsible entity; or
  • For insured plans that are neither multiemployer plans nor subject to federal COBRA, the insurance company is the responsible entity. Typically this will arise where the employer has less than 20 employees or is a church plan.

Only the responsible entity may receive the payroll tax credit; an employer and insurer may not agree by contract that the other entity will advance the subsidy and receive the payroll tax credit.

Eligible Individuals

In general, employees will be eligible for the subsidy if they were involuntarily terminated from employment between September 1, 2008, and December 31, 2009 and are otherwise eligible for continuation coverage. Spouses and dependents can separately be eligible, and may sometimes be entitled to receive a subsidy independently from the employee. For example, in the case of a divorce after COBRA has been elected following involuntary termination of employment, an ex-spouse may be eligible. Note that if the divorce occurs before an involuntary termination, however, the ex-spouse will not be eligible for the subsidy.

Individuals who are not “qualified beneficiaries” under federal COBRA will not be eligible for the subsidy. For example, if a state continuation statute requires for coverage to extend to domestic partners, who are not qualified beneficiaries under federal COBRA, the domestic partners will not be eligible for the COBRA subsidy. If coverage is provided to eligible and ineligible individuals, the premiums must be bifurcated if an incrementally higher premium is charged with respect to the coverage being provided to the nonqualified beneficiary.

All employees who were involuntarily terminated from employment are eligible for the subsidy, not simply those terminated in connection with a reduction in force. Whether or not there is an “involuntary termination” is often a facts-and-circumstances issue. For example, the following qualify as involuntary terminations:

  • An individual is laid off;
  • An individual who was hired on a seasonal or temporary basis is let go;
  • The employer reduces an individual’s hours down to zero and such reduction results in loss of health coverage (for example, if the employer tells an employee not to report to work for the next six weeks and, as a result, the individual is no longer eligible to participate in the company’s health plan, the individual will be considered to have been involuntary terminated);
  • An individual agrees to an early retirement or volunteers to accept a severance agreement in connection with a reduction in force;
  • An individual quits in response to an employer closing a plant and telling employees they may remain employed if they are willing to move to another state;
  • An individual quits in response to an involuntary reduction in hours from full-time to part-time; and
  • An individual is called to active military duty.

Terminations of health coverage without a loss of employment will not qualify (e.g., if a dependent child ages out of the plan or a spouse loses coverage as a result of divorce while the employee is still working). Death and disability do not qualify as involuntary terminations of employment for these purposes.

In summary, any “material negative change in employment” triggered by employer action will qualify as an involuntary termination. The Treasury Department is saying that, if in doubt, the conservative answer is to provide the subsidy. Employer groups are asking the departments to publish a “good faith standard” such that, if an agency later audits and makes a different determination regarding involuntary termination than the one the employer had made, the employer will be held harmless if the employer acted in good faith.

Finally, individuals are ineligible for the subsidy if their modified adjusted gross income (“AGI”) exceeds $145,000 ($290,000 for joint filers), and the subsidy is phased out if their modified AGI is between $125,000 and $145,000 ($250,000 and $290,000 for joint filers). However, employers will not be required to track the individuals’ income. In fact, they will be required to provide the subsidy, regardless of the individual’s income, absent the individual’s permanent waiver of the subsidy.

Eligible Coverage

In general, all health plans that are normally subject to COBRA, except health Flexible Spending Arrangements (“FSAs”), are eligible by the subsidy. This includes, for example, group health, dental, and vision plans, and Health Reimbursement Arrangements (“HRAs”). In some cases retiree coverage will also qualify for the subsidy. Continuation coverage provided under health plans maintained by the federal government, or a state or local government, are eligible for the subsidy. Finally, coverage provided under comparable state continuation laws also is eligible.

Note that if a plan is not required by federal or state law to provide continuation coverage, the coverage is not eligible for the subsidy. For example, if a church plan is not subject to either federal or state continuation requirements, but voluntarily provides COBRA-like coverage, the subsidy is not available.

An employer may, but is not required to, allow a qualified individual to change coverage options. For purposes of the subsidy, when the individual makes an initial election, the coverage must have the same or lower cost. During open enrollment, the individual may make any change and the subsidy will be available even on a higher cost option. Note that ARRA includes a special rule that the option to change coverage is not available if the only coverage eligible for the election is dental, vision, or other ancillary benefits.

Calculating the Amount of the Subsidy

As noted above, the amount of the subsidy is 65 percent of the COBRA premium that the individual would otherwise be required to pay to purchase the coverage. For example, assume that under federal COBRA, or a comparable state continuation statute, the maximum premium that may be charged to an individual is $1,000 per month (federal COBRA generally limits the premium to 102 percent of the cost of coverage for similarly situated active employees). If the individual would normally be charged the full $1,000, but is entitled to the subsidy, he or she will only need to pay $350. The employer (or insurance company) will pay, and be reimbursed for, the remaining $650. If, on the other hand, the employer subsidizes $800 of the monthly premium, meaning the individual is only charged $200 per month for the coverage, he or she will pay a reduced premium of $70 (35 percent of $200), and the employer or insurer will be entitled to a credit in the amount of $130 (65 percent or $200).

The 65 percent subsidy is calculated based only on after-tax premium amounts paid by an individual. Thus, if an individual is allowed to elect to make pre-tax contributions (e.g., out of severance payments) to pay for the full COBRA premiums, he or she will not be entitled to the subsidy. If, however, the employer provides taxable cash in the amount of the COBRA premiums paid by the individual that may be used for any purpose, the full subsidy will be available.

Commencement of the Subsidy

The subsidy applies beginning with the first period of coverage after February 17, 2009. In other words, if a plan requires qualified beneficiaries to pay COBRA premiums monthly, the subsidy was available beginning March 1. There is a transition rule for individuals who paid 100 percent of their COBRA premiums during the first 60 days after the date of enactment. In such a case, the employer/insurer may either (1) reimburse the individual for 65 percent of the premiums paid, or (2) provide a credit for such amount to offset future premiums (provided it is reasonable to believe that the credit will be used within 180 days).

When ARRA was first enacted, a common belief was that the employer or insurer would automatically reduce the premiums for an individual who was involuntarily terminated from employment. The agencies have subsequently clarified that the premium reduction may not happen automatically -- the individual must first indicate eligibility for the subsidy (e.g., must not be eligible for other group coverage). The model notices, discussed below, include an election form for this purpose.

Period of Coverage

The subsidy is generally available for up to nine months, but will never extend the maximum period of continuation coverage (typically 18 months for terminations of employment under COBRA). For example, assume an employee is involuntarily terminated on September 1, 2008, becomes eligible for COBRA, and elects coverage. The individual then becomes eligible for the subsidy on March 1, 2009. In this scenario, the 18-month COBRA eligibility period began running on September 1, 2008, and the 9-month maximum COBRA subsidy period began running on March 1, 2009.

There is currently a rule under COBRA that allows the employer to determine when to “start the clock” for COBRA coverage if the employer initially provides a period of subsidized coverage. For example, if an individual terminates employment on March 1, 2009, and remains covered at the same premium rate as that applicable to active employees (or receives COBRA coverage at no cost to himself) for three months, the employer can determine, in its plan documents, whether the COBRA coverage period will begin running on March 1, 2009 or June 1, 2009. With respect to the subsidy, the nine month period of eligibility will similarly begin running at the time that the employer starts the clock on the COBRA coverage period. Thus, if the employer begins counting the COBRA coverage period on the date of termination (March 1, 2009 in the example above), and the employee receives coverage at no cost to himself for the first three months, he will only be eligible for the subsidy for a maximum of six months (after the three month period expires).

An individual’s eligibility for the subsidy will cease on the date that he or she becomes eligible for coverage under another health plan (unless the individual is only eligible for dental, vision, or other ancillary coverage). Note that this differs from the normal COBRA rule that an individual will lose eligibility for COBRA continuation coverage upon enrolling in another group health plan. However, an individual will lose subsidy eligibility only if the individual can actually enroll in and receive coverage under the other plan. For example, if the individual is only eligible for another group health plan that includes a three-month waiting period, the individual will remain eligible for the subsidy during the waiting period. Similarly, if an individual was eligible to enroll in a spouse’s plan when terminated from employment last fall (and chose not to), but was not eligible to enroll as of March 1 when the subsidy would be available, if the individual made a special enrollment election, then the individual would be eligible for the subsidy.

If an individual becomes eligible for other health coverage, the individual must notify the group health plan in writing. The DOL has provided a model form for this purpose. If the individual does not provide notice, a penalty of 110 percent of the subsidy provided after termination of eligibility will apply.

An open issue is whether an entity’s knowledge or ignorance of an individual’s eligibility for other coverage will interfere with the entity’s ability to receive a payroll tax credit for providing the subsidy. According to informal Treasury staff comments, if an entity provides the subsidy and claims the payroll tax credit without knowing that the individual was eligible for other coverage, the entity may properly claim the payroll tax credit. However, once an entity has knowledge of an individual’s eligibility for other coverage, it is obligated to disallow the subsidy. It is still an open question whether the employer or insurer has an obligation to affirmatively investigate whether the individual is eligible for other coverage.

Extended Election Period

ARRA provides for an extended COBRA election period for individuals who would have been eligible for the subsidy with respect to federal COBRA coverage but either (1) did not elect coverage or (2) elected coverage and let it lapse. These individuals must have been provided a special notice by April 18, 2009, and given a 60-day period (beginning on the date the notice was provided) in which to elect COBRA coverage. If these individuals choose to take advantage of the election, their coverage will only be retroactive to first period of coverage after February 17, 2009 (e.g., March 1), not to the original date of COBRA eligibility. Note that the gap in coverage in this situation must be disregarded for purposes of the HIPAA pre-existing condition rules.

Notice Requirements

Responsible entities are subject to specific notice requirements with respect to the subsidy. A violation of these requirements will be a deemed violation of the current COBRA notice rules, and will be subject to the same penalties ($110 per day, per violation). The DOL has issued the following four model notice packets which may be used for these purposes:

  • General Notice (for federal COBRA), full version: This notice may be used in connection with all qualifying events where the general COBRA notice is sent after February 17, 2009. It includes information about the subsidy, as well as the information that must be included in a general COBRA notice. This notice must be sent within 44 days of the qualifying event.
  • General Notice (for federal COBRA), abbreviated version: This version may be sent to individuals who became eligible for, and elected, COBRA coverage on or after September 1, 2008, and was still enrolled in such Coverage when this notice was provided. DOL has said that April 18, 2009, is a safe harbor deadline for providing this notice. An open question is whether a deadline may/must be imposed by which an individual must elect the subsidy.
  • Extended Election Period Notice (for federal COBRA): This notice may be sent to all individuals who were involuntarily terminated on or after September 1, 2008, and were not enrolled in COBRA when this notice was provided. This notice must have been sent by April 18, 2009.
  • Alternative Notice (state continuation coverage): This notice may be sent by insurance companies to all individuals who had qualifying events on or after September 1, 2008.
  • No notice required: The DOL’s current position is that individuals who were not involuntarily terminated from employment who received their COBRA notices before February 17, 2009, do not have to receive any notice regarding the subsidy.

The DOL has clarified that the model notices and forms may be amended to suit an employer’s needs. However, all of the information included in the models must be provided.

Refundable Payroll Tax Credit

The COBRA subsidy will take the form of a refundable payroll tax credit on the responsible entity’s quarterly employment tax returns (Form 941). The amount of the subsidy/credit claimed on the return will be treated as having been deposited as of the first day of the quarter, and employers will thus be allowed to reduce their corresponding deposits -- for employee income and FICA tax withholdings, and employer FICA tax obligations -- accordingly. If the subsidy/credit amount exceeds the relevant quarterly payroll tax liabilities, the entity will have the option of applying the excess amount toward the next quarter’s payroll tax obligations or obtaining a refund. Entities must claim the payroll tax credit in the year in which it arises, but may claim it in any quarter within that year.

An entity is eligible to claim the payroll tax credit as of the date that the individual’s reduced premium payment is received. Note that the credit does not arise on the date that the responsible entity pays the subsidy. It is not clear by whom the payment must be received before eligibility for the tax credit arises. In other words, an open question is when the payment is “received” if the responsible entity is not the same as the entity that collects the premiums from the individuals.

Reporting Requirements

Responsible entities must submit reports as required by Treasury/IRS, and must maintain the following documentation:

  • Information on the receipt, including dates and amounts, of the individuals’ 35 percent payment;
  • For insured plans, a copy of the invoice or other supporting statement from the insurance carrier and proof of timely payment of the full premium to the insurance carrier;
  • For self-insured plans, proof of the premium amount and proof of the coverage provided to the individuals;
  • Attestation of involuntary termination, including the date of the involuntary termination;
  • Proof of each individual’s eligibility for, and election of, COBRA between September 1, 2008, and December 31, 2009;
  • Social Security numbers of all covered employees, the amount of the subsidy reimbursed with respect to each covered employee, and whether the subsidy was for one individual or two or more individuals; and
  • Other documents necessary to verify the correct amount of reimbursement.

Presumably responsible entities also will have to issue information reporting documents (e.g., Form 1099) to report to individuals the amount of the COBRA subsidy provided on their behalves. The subsidy is not included in the individual’s income, but an individual who exceeds the income threshold will be required to report subsidy payments on his or her Form 1040 and repay those subsidy amounts to the U.S. Treasury. The IRS will likely address this issue later in the year.

Appeal Rights

Eligible individuals who are denied a COBRA subsidy may submit an appeal -- which will be reviewed by the DOL in the case of ERISA plans or CMS in the case of state continuation coverage -- within 15 business days. The agency determination is de novo and is the final determination. It is currently unclear the extent to which employers or insurers will be required to submit information to aid the agencies in their review of appeals.


An entity that fails to comply with the subsidy provisions is subject to the regular COBRA penalties of $100 per day, per violation. Further, any mistakes in subsidy administration may result in payroll tax penalties. If an entity claims a subsidy for someone and the IRS later determines that the person was not eligible or the amount was incorrect, the entity will have underpaid its payroll tax liability.

In addition, if an entity provides a subsidy to an individual, thereby “certifying” that the individual was eligible, and it later turns out that the IRS believes the entity “should have known” the individual was not really eligible, the entity may have violated the False Claims Act. This issue is all too likely to arise if, for example, the entity provides a subsidy to someone who was eligible for other coverage of which the entity had reason to know (perhaps because the person was over age 65 and, because of Medicare eligibility, was therefore ineligible for the subsidy). False Claims Act violations can lead to significant liability, including treble damages (e.g., three times any payroll tax credit improperly received) plus statutory penalties. With the IRS very concerned about fraud in connection with the subsidy, and hiring thousands of new employees, in part, to help administer the subsidy provisions, employers and insurers may continue to feel the effects of this temporary program for a long time after its expiration.


The COBRA subsidy has created a number of administrative and legal issues for employers, who are struggling to implement the provisions quickly and often without sufficient guidance to feel confident they are in compliance. New issues seem to develop every day -- sometimes from lack of agency information and sometimes in response to agency information. And unfortunately, with the White House and Congress committed to enacting comprehensive health care reform in 2009, this is not likely to be the last compliance challenge, or use of the payroll tax platform to deliver subsided coverage, that employers will face this year.

For more information, please contact any of the following lawyers:

Susan Relland

Michael Lloyd,, 202-626-1589

Garrett Fenton,, 202-626-5562

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