By: HUB’s EB Compliance Team

A recent guilty plea announced by the Department of Labor is a good object lesson for employers enticed by products or services proclaiming to reduce health insurance costs. The promoters of a scheme, that went by the name of “Classic 105,” caused at least $40 million in losses to plan participants and in unpaid taxes.

A Classic Design

The scheme involved something we’ve written about before: the dreaded double-dip. It comes in a variety of forms, but the basic idea is described well in the DOL’s press release:

[Defendants] marketed Classic 105 to employers to provide a supplemental benefit plan to reimburse employees for medical expenses such as co-pays and deductibles. Classic 105 claimed to be comprised of several components including a tax-exempt contribution of between $1,000 and $1,600 per month made by an employee …. [Employers were] told… that participants would never have to make out-of-pocket payments and because of the tax savings, most participants would receive an increase in their net take home pay.

[Defendants] arranged for the contributions to appear as a series of "paper transactions" that, in effect, did nothing more than reduce participants' taxable wages and employers' FICA payments improperly, without their knowledge of the impropriety. Consequently,…at least $20,000,000 in federal FICA taxes as well as a "significant" amount of personal income taxes [were] underpaid, amounts for which the employer-clients and employee-participants are now individually responsible. (emphasis supplied).

In other words, participants contribute money and get almost all of their money back as medical reimbursements (minus the promoter’s fee, of course). As a result, medical expenses are reimbursed tax-free, the employer and employees reduce their taxes without reducing the employees’ take home pay, and the only loser is the IRS. (That is, until the IRS or DOL figures it out and then makes everyone pay the back taxes that they owe – then the IRS is usually the only winner.)

That Classic Look

The sinister part of these schemes is that they share some features with legitimate benefit plans. Health flexible spending accounts (“FSAs”) also have employee contributions and reimburse medical expenses tax free. Similarly, legitimate supplemental benefit plans do exist where employers and/or employees contribute and receive tax-free reimbursement for out-of-pocket medical expenses.

However, both FSAs and legitimate supplemental plans have an element that the double-dip lacks: a real risk of loss. With Health FSAs, for example, if an employee does not use all the contributions he or she has made for a year, the remainder is forfeited. In legitimate supplemental plans, employees pay a premium and they may receive reimbursements that are more than, or less than, their premium contribution for the year. Congress built in the risk of loss in exchange for the tax free benefit. If there’s no real risk of loss, the scheme is most likely illegitimate and illegal.

Health FSAs are also subject to contribution limits and nondiscrimination testing. Legitimate supplemental plans have to be truly supplemental to other primary medical coverage, have to be insured, and generally should have a premium cost that is no more than 15% of the cost of the primary coverage, among other requirements.

Avoiding a Classic Blunder

If an employer is approached by a promoter of these schemes, what can be asked to avoid getting yourself and your employees in hot tax water?

  1. Do employees get all their contributions back or is there a real risk of loss? – If the answer is they get all their contributions back and there’s no real risk of loss (other than payment of fees), then this is likely not a legitimate scheme.
  2. For supplemental plans (not health FSAs): Is this plan insured? Who is the carrier? - Self-funded supplemental plans are likely not legitimate. There should be an insurer/carrier.
  3. For health FSAs (or other plans that say they are self-funded): What nondiscrimination rules apply? Do you perform the testing? – Health FSAs and self-funded plans are generally subject to nondiscrimination testing requirements. If the plan is self-funded (meaning it’s not insured), but they say nondiscrimination doesn’t apply, then the plan is suspect.

Additionally, if a supplemental-only plan is funded through a multiple employer welfare arrangement (“MEWA”), as the Classic 105 was, that is a red flag. There certainly are legitimate, well-run MEWAs, but they tend to provide major medical benefits. A supplemental-only plan that is a MEWA should be viewed with suspicion.

As the adage goes, if it looks too good to be true, it probably is. If you need help evaluating a product like this, talk to your HUB Advisor. You can also view more compliance articles in our Compliance Directory.

NOTICE OF DISCLAIMER

The information herein is intended to be educational only and is based on information that is generally available. HUB International makes no representation or warranty as to its accuracy and is not obligated to update the information should it change in the future. The information is not intended to be legal or tax advice. Consult your attorney and/or professional advisor as to your organization’s specific circumstances and legal, tax or other requirements.