Timing, Severance, And COBRA Subsidies

At a March 24 Compliance Assistance Webcast on the new COBRA subsidies, Russ Weinheimer of the IRS's Office of Chief Counsel and Kevin Knopf, attorney-adviser in the Office of Tax Policy at the Department of the Treasury, discussed severance payments for health care in relation to the subsidies.

One key to determining whether an individual receiving health care benefits as part of a severance package is eligible for the COBRA subsidy is that the individual must both have been involuntarily terminated and have lost coverage in the period from Sept. 1, 2008, through Dec. 31, 2009.

Thus, an individual who was terminated on Aug. 1, 2008, received a severance package that pays health care premiums for three months, and becomes COBRA-eligible on Nov. 1, 2008, is not eligible because the termination occurred before Sept. 1, 2008. In the same sense, an individual who is terminated on Dec. 1, 2009, is provided a severance package with health care benefits for three months, and loses coverage and becomes COBRA-eligible on March 1, 2010, is not eligible for the subsidy because the loss of coverage occurred after Dec. 31, 2009.

If both the termination and loss of coverage occur within the specified period, determining the amount of subsidy in a severance situation depends on how the employer structures the subsidy.
For example, assume an employer provides a three-month severance package that includes health care payments of $800 per month for coverage that costs $1,000 per month, resulting in a $200 employee contributon for three months. Two possibilities are as follows:

(1) employer treats the severance payment as part of COBRA and subsidizes COBRA coverage for three months. In this situation, the individual would only pay 35% of the remaining $200 per month, and the employer would be reimbursed for 65% of the $200 per month. After three months, the individual would be charged the full $1,000 per month; however, the COBRA subsidy would still be available for six more months and would require the individual to pay 35% of $1,000 (and the employer could be reimbursed for the remaining 65% of $1,000).

(2) employer treats the severance payment as an extension of the regular health care coverage for three months; after three months the individual is eligible for COBRA. In this situation, the individual would not be on COBRA for the first three months and thus would not be eligible for the subsidy (and would be required to pay the full $200 per month). After three months, the individual would become eligible for COBRA and would be charged the full $1,000 per month; however, the COBRA subsidy would then be available for the full nine months and would require the individual to pay 35% of $1,000 (and the employer could be reimbursed for the remaining 65% of $1,000).

In addition to severance payment issues, this discussion raises a potential problem at the end of the subsidy period. Note that an individual must both have been involuntarily terminated and have lost coverage in the period from Sept. 1, 2008, through Dec. 31, 2009, to be eligible for the subsidy.

In December 2009, many of those who are involuntarily terminated may not lose coverage under the terms of their plans until January of 2010, which would make them ineligible for the subsidies. Plan sponsors should consider this situation and determine whether additional employee communications may be needed or whether plan adjustments need to be made.