COBRA Audits – Another Worry for Employers

June 2012Newsletters For Your Benefit

In March of this year, the Internal Revenue Service published a guide to be used by its examiners in monitoring compliance by employers and group health plan sponsors with the requirements under the Consolidated Omnibus Budget Reconciliation Act (COBRA). In the recent past, it has been the Department of Labor that has been more active in enforcement of the rules for healthcare continuation coverage, but it is feared that the release of these guidelines may signal yet another new IRS audit initiative, for which employers should be prepared.

COBRA was enacted in 1985 to give covered employees (those covered under an employer-sponsored group health plan) and their families who otherwise would lose coverage as a result of a qualifying event the right to continue coverage under that plan at their own expense. Among the qualifying events that may trigger these healthcare continuation rights are retirement, termination of employment (other than by reason of gross misconduct), reduction in hours, death, or entitlement to Medicare benefits. Among the qualifying events that might affect family members identified as qualified beneficiaries are divorce or legal separation from the covered employee and loss of dependent child status. Generally, the coverage available under COBRA must be identical to that received immediately prior to the qualifying event.

In order to assure that covered employees and qualified beneficiaries are made aware of their rights to continuation of healthcare coverage, written notice of these rights must be provided to each covered employee and spouse at the time coverage under group health plan commences. The employer must notify the plan administrator within 30 days after the covered employee’s death, termination, reduction in hours, or entitlement to Medicare, and each covered employee or qualified beneficiary must notify the plan administrator within 60 days of any divorce or legal separation or of a child ceasing to be a dependent. The plan administrator then is obligated to notify the qualified beneficiaries of their COBRA rights within 14 days after receiving notice of the qualifying event.

Failure to comply with the COBRA requirements may trigger an excise tax in an amount equal to $100 per qualified beneficiary (but not more than $200 per family) for each day of the non-compliance period. Both the employer that maintains the plan and the plan administrator may be liable for the excise tax. Even when the failure is unintentional and due to reasonable cause, with no willful intent, excise taxes of up to $500,000 may be imposed each year.

To monitor compliance, the examination guidelines suggest that the auditor request the following information:

  1. A copy of the healthcare continuation coverage procedures manual;
  2. Copies of standard healthcare continuation coverage form letters sent to qualified beneficiaries;
  3. A copy of the taxpayer’s internal audit procedures for healthcare continuation coverage;
  4. Copies of all group healthcare plans (and, if necessary, compare the amount of healthcare expenses claimed on the employer’s return as a deduction to confirm that all plans are listed), and
  5. Details pertaining to any past or pending lawsuits filed against the employer for failure to provide appropriate continuation coverage.

Then, based on the procedures in place, the examiner is directed to probe specific areas for noncompliance and to interview responsible parties regarding the number of qualifying events occurring in the year under examination, the method by which qualified beneficiaries are notified of their rights to continuing healthcare coverage, the method by which the plan administrator is notified that a qualifying event has occurred, the election made by qualified beneficiaries, and the premium paid by qualified beneficiaries.

While the guide is intended for IRS field auditors, it can serve as an internal checklist to be used by employers to assure that they will be prepared in the event of a COBRA audit.

For more information regarding this topic, please contact Susan Foreman Jordan or any member of the Fox Rothschild LLP Employee Benefits and Compensation Planning Practice Group.