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Updates on Health and Welfare

Focus On Employee Benefits

Health and Welfare: The Last Holdout State: Wisconsin Finally Conforms to the Federal Tax Treatment of Health Coverage Provided to Non-Tax-Dependent "Adult Children"

Garrett Fenton and Fred Oliphant

One of the more well-known provisions of the Patient Protection and Affordable Care Act, as amended ("PPACA"), requires all group health plans and health insurance policies offering coverage to participants' children to extend that offer of coverage to any child of the participant who is under age 26, regardless of whether the child qualifies as the participant's "dependent" for federal income tax purposes (e.g., regardless of the child's marital or student status, residence, or source(s) of support).1 A separate provision amended the Internal Revenue Code to provide that any health coverage under a group health plan for a so-called "adult child" -- a term often used to describe a participant's child who does not qualify as the participant's tax dependent, but does qualify for health coverage under the terms of the group health plan -- could be provided to an employee-participant on a tax-free basis, until the end of the calendar year following the child's 26th birthday. (Prior to PPACA, the value of any health coverage provided to a participant's child who did not qualify under a slightly modified version of the test for determining tax dependency, under the Internal Revenue Code, was taxable to the participant.)

Many states' tax laws "piggy-back" off the current federal income tax treatment of health coverage provided to participants and their beneficiaries. The PPACA provision amending the Internal Revenue Code to provide for the tax-free treatment of health coverage for adult children thus operated to amend these "conforming" state tax laws, automatically, in similar fashion. However, when PPACA was enacted in March of 2010, a number of applicable state laws were not so linked. In such instances, they referred to a specific version of the Internal Revenue Code that was in effect as of a prior date (i.e., before the effective date of PPACA's new federal income tax exclusion for health coverage provided to adult children), did not refer to the Internal Revenue Code at all, and/or provided their own rules for determining the tax treatment of health coverage provided to employees and their family members. In these "non-conforming" states, health coverage provided to adult children would have been subject to state income taxes in the absence of a change in the applicable state tax laws. At the time that PPACA was enacted, nearly two dozen states were non-conforming.

In the months following PPACA's enactment, the various non-conforming states, one-by-one, began to enact legislation conforming to the Internal Revenue Code's treatment of health coverage provided to adult children. The last "holdout" state was Wisconsin, which finally enacted legislation in early November of 2011 that expressly incorporated and applied the PPACA-amended provisions of the Internal Revenue Code for Wisconsin state tax purposes, effective retroactively to January 1, 2011. Accordingly, under current state tax laws, any group health coverage provided to an adult child, pursuant to PPACA's mandate, generally will not be subject to income tax in any state.

The non-conforming states' collective action to conform their tax laws to the Internal Revenue Code's treatment of health coverage provided to adult children has been praised by employers and employees alike. It has been viewed as particularly welcome relief for multi-state employers that otherwise might have been required to undertake an onerous administrative burden associated with subjecting such health coverage to state income tax and withholding obligations in various non-conforming states.


Health and Welfare: Department of Labor Guidance Indicates Possible Delay of Summary of Benefits and Coverage and Uniform Glossary Provisions, and Clarifies Mental Health Parity Rules

Garrett Fenton and Fred Oliphant

On November 17, the Department of Labor ("DOL") issued the seventh installment in its series of frequently asked questions regarding the Patient Protection and Affordable Care Act ("PPACA"). Specifically, the "FAQs About Affordable Care Act Implementation Part VII and Mental Health Parity Implementation" (available at provide guidance on the PPACA provisions relating to the summary of benefits and coverage documents ("SBC") and uniform glossary, as well as implementation of the Mental Health Parity and Addiction Equity Act of 2008 ("MHPAEA").

SBC Provisions

The guidance includes one FAQ relating to the timeline for the issuance of future guidance relating to -- and the effective date of -- the PPACA provisions that require the development and distribution by group health plans (and health insurers) of a summary of benefits and coverage document and uniform glossary of commonly-used health coverage-related terms. Last August, the DOL, along with the Departments of Health and Human Services ("HHS") and the Treasury (collectively, the "agencies") issued proposed regulations, templates, instructions, and other related guidance implementing these provisions, with a proposed effective date of March 23, 2012. See our October 3, 2011 Focus On Employee Benefits. The agencies received a number of public comments in response to the proposed regulations, many of which argued that there was not enough time for plans and health insurers to come into compliance with the SBC and uniform glossary provisions by March 23, 2012, particularly in light of the fact that the agencies have not yet issued final regulations on the subject.

The FAQ notes that the agencies intend to issue final regulations, "as soon as possible," that will take into account the public comments and other stakeholder feedback received to-date. More importantly, the FAQ confirms that group health plans and health insurers will not be required to comply with the PPACA provisions relating to the SBC and uniform glossary until those final regulations are "issued and applicable," and the final regulations are expected to include an applicability date that gives group health plans and health insurers "sufficient time to comply." Despite its relative vagueness, this statement has been well-received by employers, health insurers, and practitioners who continue to hope for a definitive delay of the effective date of these provisions.

MHPAEA Provisions

Most of the guidance -- six out of the seven FAQs -- relates to a range of issues under MHPAEA. By way of review, the Mental Health Parity Act of 1996 ("MHP") prohibited group health plans that offered coverage for mental health benefits from imposing any annual or lifetime dollar limits on those benefits that were lower than any such dollar limits for medical and surgical benefits under the plan. MHPAEA supplemented MHP, and requires group health plans to ensure that "financial requirements" (such as copayments, deductibles, coinsurance, and out-of-pocket limitations) and "treatment limitations" (such as office visit limits) applied to mental health and substance use disorder benefits be no more restrictive than the "predominant" financial requirements and treatment limitations applied to substantially all medical and surgical benefits under the plan. MHPAEA also prohibits a group health plan from imposing separate financial requirements or treatment limitations solely for mental health or substance use disorder benefits. The agencies issued interim final rules implementing MHPAEA on February 2, 2010. These rules contain specific arithmetical testing standards for ensuring compliance with MHPAEA.

The interim final rules under MHPAEA also provide separate parity standards for "non-quantitative" treatment limitations -- e.g., medical management standards that limit or exclude benefits based on medical necessity or appropriateness (or based on whether a treatment is experimental or investigative); formulary designs for prescription drugs; standards for provider admission to participate in a network; methods for determining usual, customary, and reasonable fee charges; refusals to pay for higher-cost therapies until it can be shown that a lower-cost therapy is not effective; and exclusions based on a failure to complete a course of treatment. The interim final rules generally prohibit plans from imposing these types of limitations with respect to mental health and substantive use disorder benefits more stringently than with respect to medical and surgical benefits.

The FAQs clarify a number of issues under MHPAEA, for example:

  • A group health plan that requires prior authorization from a utilization reviewer regarding the medical necessity of a mental health or substance use disorder treatment, but not medical or surgical benefits, will be in violation of MHPAEA's prohibition on separate non-quantitative treatment limitations that apply solely to mental health and substance use disorder benefits.
  • A group health plan that requires the same prior authorization standards to be met with respect to comparable categories of medical and surgical benefits as well as mental health and substance use disorder benefits will nonetheless violate MHPAEA if, in practice, the plan routinely approves the medical and surgical benefits under a more generous limitation standard than the mental health and substance use disorder benefits (e.g., routine approval of seven days of inpatient medical and surgical benefits, as opposed to one day of inpatient mental health and substance use disorder benefits). Although the interim final rules under MHPAEA would permit a plan to apply such "non-quantitative" treatment limitations differently to mental health and substance use disorder benefits if the difference was permitted under "recognized clinically appropriate standards of care," a plan could not apply stricter non-quantitative treatment limitations -- with respect to the plan's benefits as well as its "care management" practices -- to all benefits for mental health and substance use disorder benefits than for medical and surgical benefits.
  • An example in the FAQs illustrates how a plan may design and implement medical management techniques (like prior authorization requirements) for both mental health and substance use disorder benefits, and medical and surgical benefits -- based on the application of certain specified processes, strategies, evidentiary standards, and other factors, in a "comparable" fashion -- without violating MHPAEA.
  • A group health plan that implements evidentiary standards -- such as concurrent review for inpatient care where there are high levels of variation in length of stay -- that, in practice, end up impacting substantially more mental health and substance use disorder conditions than medical and surgical conditions, will not be in violation of MHPAEA, provided that the evidentiary standards are applied no more stringently to mental health and substance use disorder conditions than to medical and surgical conditions.
  • In determining the financial requirements that may be applied to mental health and substance use disorder benefits -- without violating the rule that such financial requirements can be no more restrictive than the "predominant" financial requirements applied to substantially all medical and surgical benefits in a given classification -- a group health plan will not necessarily be limited to applying the financial requirement that applies to medical and surgical "generalist" providers under the plan. For example, if the predominant copayment applied to substantially all outpatient, in-network medical and surgical benefits happens to be the copayment for a medical or surgical specialist, then the plan will be permitted to charge a copayment for outpatient, in-network mental health and substance use disorder benefits that is equal to or less than the medical or surgical specialist copayment amount.

The DOL previously has issued limited "FAQ" guidance on MHPAEA implementation issues. See, e.g., FAQ About Mental Health Parity and Addiction Equity Act (available at and FAQs About Affordable Care Act Implementation Part V and Mental Health Parity Implementation, Q&As 8-11 (available at The DOL may continue to issue such informal, sub-regulatory "FAQ" guidance in the future, at least in the context of MHPAEA and PPACA. Employers would be well-advised to stay apprised of this guidance as it is issued.


Health and Welfare: Amendment to "Pay-or-Play" Law May Require Immediate Attention by Employers with San Francisco Employees

Garrett Fenton and Gary Quintiere

On November 22, 2011, a divided San Francisco Board of Supervisors passed -- and Mayor Edwin Lee promptly approved -- legislation amending the city's Health Care Security Ordinance ("HCSO"), commonly referred to as the "pay or play" law. The HCSO amendment will likely require most employers who satisfy the HCSO's pay-or-play mandate by using health reimbursement arrangements ("HRAs") or employer contributions to health flexible spending arrangements ("health FSAs") to amend or restructure those HRAs or health FSAs before the end of the year.

By way of background, the HCSO requires a covered employer to spend a minimum dollar amount each quarter on health coverage for its San Francisco employees. Many covered employers comply with this requirement by making quarterly contributions to the City of San Francisco. However, the HCSO also permits covered employers to comply under an alternative route which many employers follow, namely, by making specified amounts available to employees under an HRA, or by contributing funds to an employee's health FSA.

New Requirements

The new legislation amends the HCSO, beginning January 1, 2012, as follows:

  • HRA funds and/or employer contributions to a health FSA must remain available for reimbursement (i.e., must not be forfeited under use-it-or-lose-it provisions), with respect to (1) an active employee (or any other person eligible for reimbursement of health care expenses through that employee) for at least 24 months after the contribution is made, and (2) a terminated employee (or any other person eligible for reimbursement of health care expenses through that employee) for at least 90 days after his or her termination of employment. Within 3 days after termination, the employer must inform the terminated employee, in writing, of the balance in his or her account, and any applicable "expiration dates" for those funds.
  • An employer must furnish a written notice/summary to each covered employee for whom HRA funds are made available for reimbursement or an employer contribution is made to a health FSA -- within 15 days after those funds are made available or the contribution is made -- which includes the HRA or health FSA balance, any applicable "expiration dates" for the funds, and other specified information.
  • An employer must report to the San Francisco Office of Labor Standards and Enforcement ("OLSE") the terms of any HRA used to satisfy the HCSO, including the costs that are eligible for reimbursement.
  • Employers that currently use HRAs or FSAs to satisfy the HCSO, and wish to continue doing so in 2012, must "roll over" to January 1, 2012 any employees' balances remaining as of December 31, 2011.
  • Employers (most commonly, restaurants) that impose "surcharges" on their customers to cover the costs of HCSO compliance must report annually to OLSE the amount that was collected through such surcharges for the year and the amount that was actually spent on employee health care. If the amount collected through the surcharges exceeds the amount spent on employee health care, then the employer must pay the difference to San Francisco or use it to reimburse covered employee health care expenditures.2
  • All employers must post in a conspicuous place -- at any workplace or job site where any covered employee works -- an annual notice that OLSE will publish by December 1 of each year. (The notice must be posted in English, Spanish, Chinese, and any other language spoken by at least 5% of the employees at that workplace or job site.)
  • If a court were to strike down or permanently enjoin certain provisions of the new legislation, then certain "alternative provisions" will become operative. These alternative provisions are similar to those that were included in an October proposal passed by the Board of Supervisors and vetoed by Mayor Leer. These alternative provisions would prohibit any forfeiture of an employee's HRA funds or health FSA contributions during the employee's employment. These provisions would have permitted the forfeiture of unused HRA funds or employer health FSA contributions only at the time of an employee's death or after an 18-month period following the employee's termination.)

Notably, because the legislation extends the HCSO beyond its original scope, i.e., by requiring employer medical plans to meet certain design specifications imposed by the City of San Francisco, it could be vulnerable to attack on ERISA preemption grounds. It seems clear, however, that a new plaintiff will have to make that argument inasmuch as the Golden Gate Restaurant Association, the entity that previously challenged the HCSO, is on record as supporting the new legislation.

In addition to signing the new legislation, Mayor Lee issued an "Executive Directive" on November 22 that, in part, requires OLSE to collect detailed data from HCSO-covered employers that offer HRAs. The Executive Directive further provides that OLSE -- in conjunction with other city departments -- will engage in employee outreach efforts to educate employees about the HCSO and how they may utilize effectively any HRA funds made available to them.


An employer maintaining a "use it or lose it" HRA to comply with the HCSO will need to review -- and likely modify -- its plan before the end of the year. In addition, an employer that currently satisfies the HCSO by making contributions to a health FSA offered through a cafeteria plan may need to abandon that arrangement or materially restructure it to ensure compliance with both the legislation and the cafeteria plan requirements. An employer must also become familiar with the various new notice, reporting, and other administrative requirements imposed under the legislation.

Finally, it is important to note that so-called "stand-alone" HRAs -- i.e., HRAs that are not integrated with a larger group health plan -- may be subject to the prohibition on annual dollar limits on "essential health benefits," enacted under the Patient Protection and Affordable Care Act ("PPACA"), for plan years beginning on or after January 1, 2014. Such stand-alone HRAs that were not in existence as of September 22, 2010 may also currently be subject to the prohibition on annual dollar limits other than certain permissible "restricted" limits -- i.e., a minimum of $750,000, $1.25 million, and $2 million, respectively, for plan years beginning on or after September 23, 2010, September 23, 2011, and September 23, 2012, respectively. Please see our October 3, 2011 newsletter.


Health & Welfare: IRS Acquiesces to Tax-Favored Treatment of GID Expenses: What does it Mean for Employer-Sponsored Health Plans?

Garrett Fenton and Gary Quintiere

The Service recently issued an Action on Decision ("AOD") announcing its acquiescence to the decision in O'Donnabhain v. Commissioner, 134 T.C. 34 (2010). In O'Donnabhain -- a case of first impression -- a divided tax court held that Gender Identity Disorder ("GID") constitutes a disease and, therefore, the taxpayer's costs incurred for hormone therapy and gender reassignment surgery were deductible as medical expenses under Code section 213. The taxpayer's expenses for breast augmentation, however, were found to have been incurred for a cosmetic procedure and therefore were not deductible. See our April 8, 2010 newsletter. The Service also indicated that it will no longer take the position reflected in Chief Counsel Advice 200603025 (Jan. 20, 2006), namely that gender reassignment surgery is cosmetic in nature and therefore any associated expenses are not deductible under Code section 213.

The Service's acquiescence to O'Donnabhain is somewhat surprising, considering that the case was one of first impression, and that there was no clear consensus among the Tax Court. Eight judges had joined in the majority's holding -- with three of those judges issuing concurring opinions that either disagreed with the analysis under section 213 or otherwise commented unfavorably on the majority's rationale. Five judges dissented.

The Service's acquiescence provides an opportunity for employer-sponsored medical plans to provide coverage for GID surgery and certain related treatments, with minimal risk that the IRS will challenge the tax-free treatment of that coverage. O'Donnabhain described very specific guidelines for determining which GID treatments could qualify as medical care, and indicated further that such determinations will vary from patient-to-patient. Accordingly, if an employer chooses to provide coverage for GID benefits, the plan and summary plan description will need to be crafted carefully in accordance with those guidelines. Moreover, fully-insured employer-sponsored plans will need to coordinate with their insurers to confirm that the desired GID benefits will be covered; there may be additional state law issues to consider in this regard. Self-funded plans will need to coordinate with their third party administrators to ensure that the appropriate guidelines and substantiation requirements will be followed, and may also need to coordinate with their stop-loss insurance carriers (if applicable) to ensure that coverage for GID benefits is not inconsistent with the plan's stop-loss contract.

1 Prior to 2014, a group health plan that qualifies as "grandfathered" under PPACA generally will not be required to offer coverage to an adult child who is eligible for employer-sponsored health coverage from his or her (or a spouse's) employer.

2 Presumably this provision was in response to a recent Wall Street Journal article revealing that many San Francisco restaurants were surcharging customers for the cost of HCSO compliance, and recouping the surcharges through permitted forfeitures. 


For more information, please contact:

Fred Oliphant,, 202-626-5834

Gary Quintiere,, 202-626-1491

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