Group health insurance can be expensive. To lower costs, some employers offer cash in lieu of benefits to employees who opt out of their group health plan. This can be an enticing option for employers on a tight budget and for employees wanting to decrease their health care expenses.
Although it is legal to offer cash in lieu of benefits, employers must adhere to specific laws to ensure compliance. This includes Section 125 of the Internal Revenue Code, the Affordable Care Act and the Fair Labor Standards Act.
Section 125 of the Internal Revenue Code
Cash in lieu of benefits can be offered to employees only through a Section 125, or cafeteria, plan, which delivers tax savings through nontaxable benefits.
Cash payments made in lieu of benefits are taxable, so they cannot be the only option offered under the cafeteria plan. (Employees must be allowed to choose between taxable and nontaxable benefits.) Also, the cash-in-lieu-of-benefits amount should be a set figure that is consistently offered to all eligible employees.
Since cash-in-lieu-of-benefits payments are taxable, they must be included in the recipient’s W-2 taxable wages.
The Affordable Care Act
If you’re an applicable large employer, your group health plan must satisfy the ACA’s “affordability” standard, which is 9.78% for 2020. This means that for the 2020 plan year, an employee’s share for self-only coverage cannot exceed 9.78% of his or her household income.
As an ALE, you can offer “opt out” cash payments to employees who decline group health coverage, but these opt-out payments must be included in your “affordability” calculation —unless the arrangement is considered an “eligible opt-out arrangement.”
With an eligible opt-out arrangement, the employee must decline your health insurance and show that he or she has minimum essential coverage through another source, such as the employee’s spouse’s or a parent’s employer-sponsored plan. These opt-out payments do not have to be included in your affordability calculation.
Note that the employer-shared responsibility provisions of the ACA forbid employers from paying for employees’ health insurance directly — and opt-out cash amounts are considered direct payments. As a precautionary measure, state in your cafeteria plan documents and enrollment materials that cash payments made in lieu of benefits should not be used to buy individual health insurance, either on or off the health insurance marketplace.
The Fair Labor Standards Act
Employers that offer cash in lieu of benefits should be very careful in terms of the FLSA, because courts have ruled that such payments must be included in overtime calculations.
In the case of Flores v. City of San Gabriel, on June 2, 2016, the 9th U.S. Circuit Court of Appeals held that employers must include cash-in-lieu-of-benefits payments in the regular rate of pay when calculating overtime under the FLSA. On May 15, 2017, the Supreme Court rejected the city’s petition for review of the 9th Circuit’s decision — effectively keeping the 9th Circuit’s ruling intact.
The implications of cash in lieu of benefits are sweeping and complex, so seek expert advice before adopting this compensation alternative.