What's in the regulations? - section 89 of Tax Reform Act of 1986 - interview

What's In The Regulations? Harry Conaway knows the Section 89 regulations better than almost anyone. He helped to write them when he was an associate tax legislative counsel at the Treasury Department.

Conaway left the department recently to join the Washington, D.C., office of the consulting firm of Mercer Meidinger Hansen Inc., where he is a principal and member of the firm's national legislative and regulatory resource group. He stays busy these days helping business clients figure out how to comply with Section 89.

In an interview, Conaway said that transition rules in the regulations will help cushion Section 89's impact on business during this first year of enforcement.

Moreover, a certain compliance shortcut tailored to the circumstances of federal, state, and local governments and some large companies may benefit those employers.

Nonetheless, Conaway expressed doubt that the law would achieve its goal of expanding health-insurance benefits to those who have inadequate coverage or none at all.

Following are excerpts from Senior Editor Roger Thompson's interview of Conaway.

How can business comply with such a complex law when regulations weren't released until two months after Section 89 took effect?

In recognition that the regulations were late, certain transition rules in the regulations contain relief for 1989. Perhaps the most important is the reasonable and good-faith compliance standard. In general, if an employer makes a reasonable and good-faith effort to comply with Section 89, the employer will be treated as having satisfied the law until 1990--notwithstanding the regulations.

The idea was not to punish employers who tried to comply early, which would have meant rewarding those employers who deferred action.

Are there other transition rules affecting Section 89's impact this year?

Yes. There are three additional major transition rules:

First, the effective date for compliance with the Section 89(k) qualified-plan requirements is deferred until 1990. [The qualification rules require that a plan be written, enforceable, permanent, and maintained for the exclusive benefit of employees. Further, employees must be notified of benefits.]

The only exception to deferral is the notice requirement. It must be satisfied by July 1, 1989.

Second, the regulations provide a transition rule under which benefit changes before July 1, 1989, do not have to be taken into account when conducting the law's nondiscrimination tests. In effect, this permits testing to occur on a half-year basis. From an administrative perspective, this should significantly reduce the burden in the first year.

Third, another transition rule permits an employer to opt out of the 75-percent benefits test by treating as taxable income the health coverage provided to the top 20 percent of the highly paid, or the top 1,000 highly paid employees, whichever is less. [The 75-percent test requires that employees who are not highly paid must receive an average benefit at least 75 percent as valuable as the average benefit for highly paid employees.]

Will many employers find this alternative to conducting the 75-percent benefits test helpful?

I think there are many employers who aren't going to be anywhere near ready to run the nondiscrimination tests in any accurate fashion this year. And they may well choose this alternative for 1989. It is far simpler and more cost-effective than to run a full-blown, 75-percent average-benefit test.

Under the regulations, are rank-and-file employees still subject to taxation on the full amount of health benefits received when their employer fails to maintain a qualified plan?

No. A special 89(k) rule caps the amount subject to taxation. The limitation is based on an employee's salary and is indexed to reflect inflation. The taxable limit for those earning less than $54,480 equals 10 percent of their actual salary, 25 percent of salary between $54,481 and $108,960, and 75 percent between $108,961 and $163,440. Those earning more are subject to taxation on the full amount of the benefit received. Under this rule, for example, there won't be any $20,000-a-year janitors being taxed on the $100,000 in medical benefits received for open-heart surgery.

Many employers haven't yet taken the first step toward compliance. Now that the regulations are out, are they already in violation of the law?

No. Employers haven't missed any deadlines yet. That's the main reason the effective dates were delayed for the 89(k) qualified-plan rules. Originally, the qualified-plan rules were to take effect Jan. 1, 1989. Without this delay, many employers already would have failed.

Will Section 89 force employers to redesign their benefit plans?

One of the nice things about Section 89 is that it doesn't require any change in health-plan design. It only governs the tax treatment of health benefits. So employers really don't have to do anything in response to Section 89 other than apply the rules to determine the taxability of coverage. Employers who haven't done anything about compliance yet are going to have a lot of work ahead of them to determine what the excess benefit is. But no employer has yet failed the nondiscrimination tests either.

How much revenue will Section 89 generate?

The initial estimate was around $300 million for the first two or three years. It's my guess that the numbers are going to be significantly greater. There is a lot more [revenue to be collected because of] discriminatory coverage, as defined by Section 89, than people originally thought.

What impact will Section 89 have on individuals who do not now have employer-provided health insurance?

The law was designed to expand health-insurance coverage. But I think just as importantly it was a tax-equity rule. There was a recognition that in many case, Section 89 will not expand coverage. What it will accomplish is to reduce the tax-favored health-benefits coverage going to the highly paid relative to the nonhighly paid.

So it won't expand coverage?

It was recognized that in many cases it will be cheaper for the employer to comply with Section 89 by taxing the highly paid rather than extending coverage to the nonhighly paid. Section 89 thus had a twofold objective. But I think it is probably going to be successful on the tax-equity side and much less successful on the expanded-coverage side.

Doesn't Section 89 impede introduction of cafeteria benefit plans at a time when employees want the kind of choice that such plans offer?

The adverse effect comes from the fact that Section 89 looks at actual coverage. Where the employer sets up an elective plan, he runs the risk that some employees will elect no coverage, low coverage, or different coverage levels. And that complicates testing. In some cases, the highly paid may end up with a discriminatory excess benefit merely because the low-paid elected out of coverage.

But if there was no intent on the part of the employer to discriminate, why is anyone being penalized under Section 89?

The law isn't looking at intent. It's looking at results.

This get back to the original policy question. The government argues that the reason for tax-favored treatment of health benefits is to expand coverage to low- and middle-income employees. The tax-favored treatment for highly paid employees is not justified unless tax-favored coverage is also being provided to other employees. So the idea is that you can't look at the employer's intent. You should look at whether low- and middle-income employees actually got a tax-favored health benefit.

Now that you are advising business clients on Section 89 compliance, have your views about the law changed?

I don't think most people in government or the private sector who were working on the law fully assessed the real administrative difficulties that would be imposed on business. Since I left Treasury, the difficulties that companies have in collecting data and making Section 89 compliance decisions have become more apparent to me.

COPYRIGHT 1989 U.S. Chamber of Commerce
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