Final Regulations Modify the Definition of Short -Term, Limited-Duration Insurance

(Parker Tax Publishing April 2024)

The IRS issued final regulations that amend the definition of short-term, limited-duration insurance in Reg. Sec. 54-9802-2 to reduce the maximum length of such coverage from 12 months to 3 months. In addition, the final regulations do not finalize amendments to Reg. Sec. 1.105-2 that provide that the exclusion from gross income under Code Sec. 105(b) for amounts paid under a health or accident insurance plan to reimburse an employee for medical expenses does not apply to amounts that are paid without regard to the amount of incurred medical expenses as defined in Code Sec. 213(d). T.D. 9990.

Background

Short-term, limited-duration insurance (STLDI) is a type of health insurance that is primarily designed to fill temporary gaps in coverage that may occur when an individual is transitioning from one plan or coverage to another, such as transitioning between employment-based coverages. STLDI is excluded from the definition of "individual health insurance coverage" in the Public Health Service Act, and therefore is generally exempt from the applicable federal individual market consumer protections and requirements for comprehensive coverage. Under Reg. Sec. 54.9801-2, STLDI is currently defined as coverage with an initial term specified in the contract that is less than 12 months after the original effective date of the contract, and taking into account renewals or extensions, has a duration of no longer than 36 months in total.

Another type of health insurance that does not provide comprehensive coverage is fixed indemnity excepted benefits coverage. Benefits are paid in a flat ("fixed") cash amount following the occurrence of a health-related event, such as a period of hospitalization or illness. Benefits are typically provided at a pre-determined level regardless of any actual health care costs incurred by a covered individual with respect to the qualifying event. Although a benefit payment may equal all or a portion of the cost of care related to an event, it is not necessarily designed to do so, and the benefit payment is made without regard to the amount of medical expense incurred.

The taxation of amounts received by an employee from accident or health insurance where the premiums or contributions are paid on a pre-tax basis is determined under Code Sec. 105. Code Sec. 105(a) provides that amounts received by an employee through accident or health insurance for personal injuries or sickness are included in gross income, except as otherwise provided in Code Sec. 105. Code Sec. 105(b) excludes from gross income amounts paid by the employer to reimburse an employee's expenses for medical care (as defined in Code Sec. 213(d)). Under Reg. Sec. 1.105-2, the exclusion under Code Sec. 105(b) applies only to amounts paid specifically to reimburse the taxpayer for expenses incurred by the taxpayer for the prescribed medical care.

Proposed Regulations

In July 2023, the IRS issued proposed regulations in REG-120730-21 that modify the definition of STLDI in Reg. Sec. 54.9801-2 to provide that such coverage would have an expiration date specified in the policy, certificate, or contract of insurance that is no more than 3 months after the original effective date. The proposed regulations also reinterpret the phrase "limited duration" to mean that the maximum permitted duration for STLDI is no longer than 4 months in total, taking into account any renewals or extensions. Further, under the new proposed definition of STLDI, a renewal or extension includes the term of a new STLDI policy, certificate, or contract of insurance issued by the same issuer to the same policyholder within a 12-month period beginning on the original effective date of the initial policy, certificate, or contract of insurance.

With respect to fixed indemnity insurance, the 2023 proposed regulations would amend Reg. Sec. 54.9831-1(c)(4) to provide that fixed indemnity excepted benefits must be paid regardless of the items or services received, actual or estimated amount of expenses incurred, severity of illness or injury experienced, or any other characteristics particular to a course of treatment received by a covered participant, beneficiary, or enrollee. The 2023 proposed regulations also would add an example to reflect the requirement that hospital indemnity and other fixed indemnity insurance must offer "noncoordinated" benefits to be considered an excepted benefit. In addition, the proposed regulations include a proposed consumer notice for individual market fixed indemnity excepted benefits coverage that is intended to ensure that such coverage is property identified in marketing, application, and enrollment (or reenrollment) materials as fixed indemnity excepted benefits coverage, rather than comprehensive health insurance that is subject to federal consumer protections.

The 2023 proposed regulations also would provide that the exclusion from gross income under Code Sec. 105(b) does not apply to amounts that are paid without regard to the amount of incurred medical expenses as defined in Code Sec. 213(d). In addition, the proposed regulations would clarify that, consistent with IRS guidance relating to certain specific types of health plans, the substantiation requirements for qualified medical expenses apply to reimbursements under all types of accident and health plans. The proposed amendments would also update several cross references in Reg. Sec. 1.105-2 to reflect statutory changes since the rules were issued in 1956.

Final Regulations

On April 3, the IRS published final regulations in T.D. 9990 that finalize the definition of STLDI provided in the proposed regulations with some modifications. The final regulations also adopt the new notice for fixed indemnity excepted benefits coverage provided in the proposed regulations but do not address any other provision of the 2023 proposed rules relating to fixed indemnity excepted benefits coverage. The final regulations also do not finalize the proposed amendments to Reg. Sec. 65.9831-1(c)(4) regarding fixed indemnity insurance benefits or the changes to Reg. Sec. 1.105-2 regarding the exclusion from gross income for employer reimbursements of medical expenses.

Under the final rules, STLDI means health insurance coverage provided pursuant to a policy, certificate, or contract of insurance that has an expiration date specified in the policy, certificate, or contract of insurance that is no more than 3 months after the original effective date of the policy, certificate, or contract of insurance, and taking into account any renewals or extensions, has a duration no longer than 4 months in total. For purposes of this definition, a renewal or extension includes the term of a new STLDI policy, certificate, or contract of insurance issued by the same issuer to the same policyholder within the 12-month period beginning on the original effective date of the initial policy, certificate, or contract of insurance. The final regulations further provide that, if the issuer is a member of a controlled group, a renewal or extension also includes the term of a new STLDI policy, certificate, or contract of insurance issued by any other issuer that is a member of such controlled group. The final regulations also retain the requirement that STLDI issuers display a consumer disclosure notice on the first page of the policy and in any marketing materials and provide updated language for the notice. The revised definition of STLDI applies to new STLDI policies, certificates, or contracts of insurance for coverage periods beginning on or after September 1, 2024. The revised notice specified in the final rules must be provided for new STLDI policies sold or issued on or after September 1, 2024, and with respect to existing coverage, upon renewal or extension that occurs on or after September 1, 2024.

With regard to the rules relating to fixed indemnity excepted benefits coverage, the final regulations adopt the new notice for fixed indemnity excepted benefits coverage offered in the

group market and update the existing notice for such coverage offered in the individual market. The content and applicability date of the notice are modified in response to comments and consumer testing. Specifically, the notice provisions for group and individual market fixed indemnity excepted benefits coverage are applicable to both new and existing coverage with respect to plan years (in the individual market, coverage periods) beginning on or after January 1, 2025. However, the IRS stated that, to provide more time to study the issues and concerns raised in comments, the final rules do not address any other provision of the 2023 proposed rules relating to fixed indemnity excepted benefits coverage.

The final regulations also do not finalize the proposed amendments to Reg. Sec. 1.105-2. According to the IRS, practitioners who opposed the proposed amendments primarily argued that the exclusion under Code Sec. 105(b) should apply with respect to the amount of any medical expenses associated with the health-related event that precipitates payments under accident or health insurance, even if the amount paid is determined without regard to the amount of actual medical expenses incurred (as is required for hospital indemnity or other fixed indemnity insurance to be considered an excepted benefit). These practitioners generally argued that only the amount in excess of the medical expenses associated with the health-related event should be included in gross income. Practitioners also raised concerns regarding collecting and paying employment taxes on amounts paid through accident or health insurance that are not excluded from gross income as well as the proper reporting of such amounts on the employee's Form W-2. Accordingly, to provide more time to study these issues and concerns, the IRS decided not to finalize the proposed amendments to Reg. Sec. 1.105-2 at this time.

Observation: The IRS reminded employers that amounts received through accident or health insurance are not taxable if premiums for the coverage are paid on an after-tax basis, thereby avoiding many of the practical concerns relating to benefits that do not meet the criteria to be excluded from gross income. The IRS said it understands that is how most premiums for hospital indemnity or other fixed indemnity insurance are paid.

For a discussion of amounts received through accident or health insurance, see Parker Tax ¶75,915. For a discussion of the exclusion for medical care expense reimbursements, see Parker Tax ¶120,110.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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