Health & Welfare: Affordable Care Act Ruled Unconstitutional by Florida District Court

Jonathan Kossak

On January 31, 2011, Judge Roger Vinson of the Northern District of Florida ruled that the recently enacted Patient Protection and Affordable Care Act ("PPACA") was unconstitutional. Florida v. HHS, No. 3:10-cv-91, 2011 U.S. Dist. LEXIS 8822 (N.D. Fla. Jan. 31, 2011). The plaintiffs in the suit included twenty-six states, two individuals, and the National Federation of Independent Business.

The primary issue facing the court was whether Congress had the power to enact PPACA's individual mandate under either the Constitution's Commerce Clause or its Necessary and Proper Clause. Ultimately, the court concluded that the Commerce Clause authorizes Congress to regulate economic activity only. The court determined that a person's choice not to purchase health care insurance is a prime example of economic inactivity, and that ruling otherwise would improperly afford Congress limitless power under the Commerce Clause.

Addressing the government's Necessary and Proper Clause argument, the court explained that the Clause is not an independent source of federal power; it merely states the proposition that Congress can make effective the powers otherwise afforded to it by the Constitution. The court acknowledged that the regulation of the health care market is a legitimate end that is within Congress's power, but concluded that the individual mandate is not an "appropriate" means because it is inconsistent with the "letter and spirit of the Constitution." Id. at *113-14 (internal quotation marks omitted). Thus, the court ruled that the mandate was necessary but not proper.

After determining that the individual mandate is unconstitutional, the court addressed the issue of severability. It concluded that the complexity and breadth of the law prevented the court from determining which provisions of the statute could function independently of the mandate. As a result, the court invalidated PPACA in its entirety and left Congress the job of fixing the law's constitutional flaws. However, the court stopped short of enjoining the law's implementation; it felt that declaratory relief was sufficient. The government has not yet requested a stay of the decision. However, because this case involved constitutional issues and the federal government as the defendant, the court's judgment only binds the government with respect to the plaintiffs (i.e., it cannot be used by any other entity who was not a party to the suit to prevent the government from implementing the health reform law). See United States v. Mendoza, 464 U.S. 154 (1984) (disallowing the use of nonmutual offensive collateral estoppel against the federal government, particularly in cases implicating constitutional dilemmas).

Even for the states that were involved in the litigation, there is some disagreement about the effect of the ruling: Press reports suggest that Democratic governors, like Colorado's John Hickenlooper (Colorado was a plaintiff in the case), are not interested in avoiding implementation, and that even some Republican governors, in states such as Georgia, Iowa, and Mississippi (all plaintiffs as well), think it would be irresponsible for them to do so. On the other hand, the media has also reported that officials in Wisconsin, Florida, and Idaho (all plaintiffs) have already stated that the court's ruling invalidated the health reform law and that there is no longer any reason to prepare to implement it.

As it stands now, two district courts have invalidated the individual mandate and two have upheld it. Appeals have already been taken to the Fourth and Sixth Circuits. In addition, the Commonwealth of Virginia, one of the plaintiffs challenging the law in the Fourth Circuit, has requested that the Supreme Court take the case on expedited review. Although the Court rarely accepts such requests, the momentum created by Judge Vinson's decision and the House's vote to repeal the law could conceivably incentivize the Court to take the case earlier than usual.

It is difficult to predict the outcome, but it seems highly likely that the liberal wing of the Court (Justices Ginsburg, Breyer, Sotomayor, and Kagan) will vote to uphold the law given that they generally have favored in their prior opinions strong federal governmental authority. Only one additional vote would be necessary to establish the law's constitutionality. Most believe that Justice Kennedy will be the swing vote, but Justice Scalia has supported the Necessary and Proper Clause argument in previous cases, and Justice Roberts might not wish his Court to develop a reputation for readily overturning Congress, as it has done on several recent occasions. Whatever the ultimate outcome, Judge Vinson's decision is both reasoned and thorough and has established that constitutional challenges to the health reform law might not be as much of a long shot as they originally appeared.

Health & Welfare: Affordable Care Act Nondiscrimination Provisions for Insured Plans

Amelia Hairston-Porter and Fred Oliphant

On December 22, 2010, the IRS issued Notice 2011-1, providing much-needed guidance addressing the Patient Protection and Affordable Care Act ("PPACA") provisions prohibiting insured group health plans from discriminating in favor of highly compensated individuals. These provisions are codified in section 2716 of the Public Health Services Act ("PHSA") and incorporated into section 9815(a)(1) of the Internal Revenue Code ("Code") and section 715(a)(1) of the Employee Retirement Income Security Act ("ERISA").

Prior to the enactment of PPACA, only self-insured group health plans were prohibited from discriminating in favor of highly compensated individuals, in accordance with rules set forth under Code section 105(h). PPACA, for the first time, extends the nondiscrimination rules already applicable to self-insured arrangements to fully-insured group health plans. The new PHSA provisions require that all insured group health plans satisfy the requirements of Code section 105(h)(2), and that "rules similar" to the rules contained in paragraphs (3), relating to nondiscriminatory eligibility classification, (4), relating to nondiscriminatory benefits, and (8), relating to certain controlled groups, of Code section 105(h) apply to such plans.

An insured group health plan that fails to comply with these rules may trigger sanctions, including (1) an excise tax under Code section 4980D of $100 per day for each individual to whom the failure relates (which generally is assessed against the sponsoring employer); and (2) possible civil action under ERISA part 5 compelling the plan to provide nondiscriminatory benefits. It is important to note that PHSA section 2716 effectively penalizes the employer (or the plan), rather than the highly compensated individual for violations of the nondiscrimination rules. Thus, highly compensated individuals receiving discriminatory benefits under a fully insured plan will not face the same income inclusion treatment under the Code section 105(h) rules as they would if they received discriminatory benefits under a self-insured plan. Limited guidance on these provisions has resulted in significant confusion among plan sponsors and employers as to the timing of compliance and subsequent enforcement of any penalties.

To address this confusion, the IRS has issued Notice 2011-1, which explains that insured group health plan sponsors will not be required to comply with the new nondiscrimination provisions until after the issuance of regulations or other administrative guidance addressing how the rules will apply to fully insured plans. As a result, plan sponsors will not be subject to penalties or sanctions for continuing to operate plans that violate PHSA section 2716 until after the issuance of such guidance. More specifically, the Service noted that in order to "provide insured group health plan sponsors time to implement any changes required as a result of the regulations or other guidance... [the resulting guidance] will not apply until plan years beginning a specified period after issuance." Presumably for calendar year plans, compliance would not be required at least until January 1, 2012.

Finally, Notice 2011-1 requests additional comments from the public on issues to be addressed in future guidance. Comments must be received by March 11, 2011, and may address any of the following issues:

• The basis for determining what constitutes a "discriminatory benefit" and what is included in the term "benefits;"
• The authority of the IRS, DOL, and HHS to provide an alternative to satisfy the requirements of section 2716 based only on an availability of coverage test;
• The application of section 2716 to insured plans once the healthcare exchanges and the employer/individual mandates become operational in 2014;
• The ability of a plan to use the definition of "highly compensated employee" in Code section 414(q) instead of the definition in section 105(h);
• Whether the nondiscrimination provisions can be applied separately for different geographic locations;
• Whether section 2716 will provide for any "safe harbor" plan designs consistent with the substantive requirements of section 105(h);
• Whether employers may aggregate different, but substantially similar, coverage options;
• The application of the nondiscrimination provisions to "expatriate" and "inpatriate" employees;
• The application of the nondiscrimination rules to multiple employer plans;
• Whether coverage provided on an "after-tax" basis should be disregarded in applying
  section 2716;
• The treatment of employees who voluntarily waive employer coverage;
• The creation of potential transition rules for mergers, acquisitions, and other corporate transactions; and
• The application of the sanctions (excise tax and civil action) for noncompliance.

Executive Compensation: Guidance on the Application of Code Section 162(m)(6)

Maria Jones and Fred Oliphant

In recently released Notice 2011-2, the Internal Revenue Service ("IRS") provides much needed guidance under Internal Revenue Code ("Code") section 162(m)(6). Section 162(m)(6) was added to the Code by the Patient Protection and Affordable Care Act, ("PPACA"), and generally limits the allowable deduction for compensation paid to an officer, a director, or an employee of a "covered health insurance provider" to $500,000 for tax years beginning after December 31, 2012. Importantly, the $500,000 deductible limitation also applies to any person who performs services for or on behalf of the "covered health insurance provider" (e.g., a consultant, or possibly, in some cases, a physician provider). The Code section 162(m)(6) deductible limit also applies to compensation (1) earned, but deferred in 2010, 2011, and 2012 and (2) to which a deduction for such deferred compensation may be taken in 2013 or for any taxable year thereafter.

Under Code section 162(m)(6), if any member of a consolidated group is a "covered health insurance provider" for the applicable years, all members of the consolidated group, whether or not they are themselves "covered health insurance providers," are subject to the $500,000 limit on compensation paid for services rendered. In other words, if any company that is part of a controlled group is considered a "covered health insurance provider" for the year, every company within the controlled group will be subject to the deductible limit under Code section 162(m)(6). Prior to the issuance of Notice 2011-2, there was concern that even a small amount of health insurance business could result in application of the $500,000 deductible limit on companies that would not otherwise be considered a "covered health insurance provider."

In response to comments from industry, the IRS has provided a "de minimis rule" to prevent application of Code section 162(m)(6) to companies with a relatively small amount of health insurance business. The IRS guidance also provides a rule that limits application of the section to organizations that are "covered health insurance providers" in both the year of service and the year of the deduction for deferred compensation with respect to compensation for services performed prior to 2013.

De Minimis Rule. Under the de minimis rule set forth in Notice 2011-2, an employer will not be treated as a "covered health insurance provider" for purposes of Code section 162(m)(6) if:

• For taxable years beginning after December 31, 2009 and before January 1, 2013, the premiums received by the employer for providing health insurance coverage (as defined in Code section 9832(b)(1)) are less that 2% of the employer's gross revenues for that taxable year. For purposes of this test, the health insurance premiums and gross revenues of all members of the consolidated group are aggregated (i.e., the controlled group rules under Code section 414(b), (c), (m), or (o) apply for this purpose).
   
• For taxable years beginning after December 31, 2012, the premiums for providing health insurance coverage as defined in Code section 9832(b)(1) that are from providing "minimum essential coverage" (as defined in Code section 5000A(f)) for that year are less than 2% of the employer's gross revenues. This test will also be applied on an aggregate basis to the members of a consolidated group.

Exception for Organizations That Are Not Covered Health Insurance Providers In the Year of Service Or the Year of the Deduction. If an organization is not excepted from Code section 162(m)(6) under the de minimis rule, and wants to avoid application of the deduction limitation, it still may be possible to do so if the organization can eliminate or minimize its health insurance business before or after 2013. As discussed above, the Code section 162(m)(6) deduction limit applies to deferred compensation attributable to services performed in a taxable year beginning after December 31, 2009 and before January 1, 2013. The Notice explains that the deduction for such deferred compensation is limited only if:

(1) the employer was a pre-2013 "covered health insurance provider" for the taxable year in which the services were performed to which the deferred compensation is attributable; and

(2) the employer is a post-2012 "covered health insurance provider" for the taxable year in which such deferred compensation is otherwise deductible.

As illustrated in the Examples set forth under Section III.A. of the Notice, if a company is considered a "covered health insurance provider" in 2010, 2011, and 2012, but the company fails to be considered a "covered health insurance provider" in a taxable year after 2013, the deferred deduction limitation on any compensation deferred in the years prior to 2013 will not apply in the year the company is not a "covered health insurance provider." Similarly, if a company is not considered a "covered health insurance provider" in 2010, 2011, and 2012, but the company subsequently becomes a "covered health insurance provider" in 2013 and any years thereafter, no deduction limit will apply to compensation deferred in years prior to 2013.

Reinsurance. Notice 2011-2 provides that for purposes of determining whether a taxpayer is a "covered health insurance provider" under section 162(m)(6)(C), premiums received under an indemnity reinsurance contract are not considered premiums from providing health insurance coverage.

Independent Contractors. For organizations that are subject to Code section 162(m)(6), the Notice provides that "applicable individuals" will not include certain independent contractors that would not be subject to Code section 409A as a result of providing substantial services to multiple unrelated customers. This exception should have the effect of preventing the deduction limit from applying to compensation paid to outside parties (including physician providers) who qualify as independent contractors under the above standard.

Effective Date and Request for Comments. Notice 2011-2 applies to taxable years beginning on or after January 1, 2010. The Notice states that any future guidance that would expand the coverage of section 162(m)(6), such as a modification of the de minimis rule, will only apply prospectively. The Notice also requests comments as to the application of the Notice, as well as the application of section 162(m)(6). Specifically, comments are requested on (1) the application of the deduction limitation to remuneration for services performed for insurers who are captive or who provide reinsurance or stop loss insurance, particularly with respect to stop loss insurance arrangements that effectively constitute a direct health insurance arrangement because the attachment point is so low; (2) the application of the term "covered health insurance provider", including the de minimis rule set forth in the Notice and possible alternative de minimis rules; (3) the application of the term "covered health insurance provider" in the case of a corporate event such as a merger, acquisition or reorganization; and (4) whether the allocation rules set forth in Notice 2008-94, Q&A-9, should be applied for purposes of determining the services and the taxable year to which deferred deduction remuneration is attributable and as to any alternatives to those rules. Comments are due by March 23, 2011.

Payroll Taxes: New York Employment Tax Audits are Increasing

Tom Cryan and Anne Batter

Over the past 12 months, we have noticed an increase in the number of New York employment tax audits. Given the record budget shortfalls that state governments are facing and the drop in tax revenues from corporate and individual returns, the increased focus on employment tax returns is hardly surprising. New York auditors have been focusing on companies that operate in multiple states (and foreign countries) that are either headquartered in New York or have a significant business presence in New York. The following is a brief outline of some of the issues that we have seen raised.

1. Taxation of Nonresidents for Services Performed in New York. Like all states with an individual income tax, New York taxes the wages earned by New York residents and the wages of nonresidents for services performed in New York. Although New York has a de minimis exception for income tax withholding for nonresidents performing services in New York for fourteen days or less, if the employee performs services in New York for more than 14 days, the employer is required to withhold New York income taxes. New York auditors will often request a company's travel and expense records to determine which employees frequently travel to New York and assess a withholding liability if the Forms W-2 or other withholding reports do not reflect New York state withholding. Section 675 of the New York State Tax Law provides that every employer required to deduct and withhold income taxes is liable for the tax that should have been withheld, plus penalties and interest.

2. Taxation of Deferred Compensation Paid to Retirees. Another common issue is the proper sourcing, for state income tax purposes, of annual and long-term bonuses, equity compensation, and deferred compensation paid to retirees and other employees who move from New York. Executives that move from one state to another state often file change of residency forms with their employer for withholding purposes. However, many types of compensation, such as annual bonuses, long-term bonuses, equity compensation and various forms of deferred compensation that are paid after the employee moved out of state, may have been earned while that individual was a resident or earned with respect to services performed in New York. With limited exceptions¹, such income remains subject to New York taxation. To pursue this issue, we have seen New York state auditors identify employees who have New York wages in earlier years, but not in later years, and then question whether any of the amounts paid in the later years were earned in New York in the earlier years.

3. Taxation of New York Resident's Wages for Services Earned Abroad. Like a U.S. citizen, a New York resident is taxable by New York on his or her worldwide wages. New York auditors often seek to gather information on whether expatriates ("ex-pats") remained residents of New York, which is a fact intensive test, during the years they were receiving payments for services performed abroad. If the ex-pats were receiving payments from a "New York employer," a withholding obligation would exist if the individuals remained New York residents.

In some instances we have seen very significant proposed employment tax adjustments related to these, and other issues. In light of the heightened scrutiny of these issues by New York and the potential for other state tax authorities to take similar steps, companies would be wise to consider reviewing their practices for tracking where employees earn their regular compensation and other types of income and putting in place practices to better track the earnings location so as to avoid company liability for state withholding taxes.

¹ U.S Code Title 4, Section 114 prohibits states from taxing the "retirement income" of nonresidents. The term "retirement income" includes income from qualified retirement plans, nonqualified deferred compensation plans paid over 10 years or more and "excess benefit" plans. Importantly, nonqualified distributions paid in a lump sum and stock options are not exempted from source state taxation under this federal rule.

For additional information, please contact any of the following attorneys in our ERISA/Employee Benefits practice:

Maria Jones, mjones@milchev.com, 202-626-6057

Anne Batter*

Thomas M. Cryan*

Amelia Hairston-Porter*

Jonathan Kossak*

Fred Oliphant*

*Former Miller & Chevalier attorney

The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.

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