In Questions 5 through 7, assume that the MLR rebates are provided only to employees participating in a group health plan both in the year employees paid the premiums being rebated (in these examples, 2011) and the year the MLR rebates are paid (in these examples, 2012).
Q5. In 2011, Daniel participated in his employer’s group health plan and received health coverage under the group health insurance policy purchased directly by his employer under the plan. The plan provides that Daniel’s employer pays for 60% of the premium for each employee, and the employee pays for 40% of the premium on an after-tax basis. Daniel does not deduct the premiums on his 2011 Form 1040.
On July 1, 2012, Daniel’s employer receives a MLR rebate of part of the 2011 group health insurance policy premiums. The MLR rebate is made in the form of a reduction in the current year premium for coverage under the group health insurance policy. In accordance with the terms of the group health plan and consistent with applicable Department of Labor (DOL) guidance, 60% of the rebate is used to reduce the employer portion of the premium due for 2012, and 40% of the rebate is used to reduce the employee portion of the premium due for 2012, but only for participants under the plan who also were participants under the plan during 2011.
Because Daniel participated in the plan during 2011 and 2012, he is entitled to a MLR rebate. As a result of the rebate and corresponding premium reduction, Daniel’s premium for 2012 coverage under the group health plan is reduced.
Is Daniel’s MLR rebate income subject to federal income tax?
A5. No. The MLR rebate that Daniel receives in 2012 is a rebate of part of his 2011 insurance premiums (a purchase price adjustment). Daniel paid taxes on his compensation as an employee and used part of the after-tax income to pay his portion of the 2011 premiums. He did not deduct the premiums; therefore, the rebate is not taxable when applied as a reduction in the amount of premiums due for 2012. In addition, because the MLR rebate is a return of amounts that have already been subject to federal employment taxes, the rebate is not subject to federal employment taxes.
Q6. Would Daniel’s MLR rebate be subject to federal income tax if the insurance company had paid the MLR rebate in cash and then the employer distributed the MLR rebate in cash to Daniel (consistent with applicable Department of Labor (DOL) guidance) rather than reducing the premiums due for 2012?
A6. No. If Daniel receives a cash distribution because of the MLR rebate, the cash also is a reduction in the cost of his 2011 insurance premiums (a purchase price adjustment) and is not taxable. In addition, because the MLR rebate payment is a return of amounts that have already been subject to federal employment taxes, the payment is not subject to federal employment taxes.
Q7. Would Daniel’s MLR rebate be subject to federal income tax if Daniel had deducted his premium payment on his 2011 Form 1040?
A7. Yes. If Daniel deducted the premium payments on his 2011 Form 1040 and receives a MLR rebate in 2012, the MLR rebate is taxable to the extent that he received a tax benefit from the deduction, regardless of whether the rebate is provided as a cash payment or a reduction in the premium due for 2012. For more information on determining whether there is a tax benefit from the deduction, see Itemized Deduction Recoveries in Publication 525, Taxable and Nontaxable Income. Because the MLR rebate is a return of amounts that have already been subject to federal employment taxes, the rebate (whether applied to reduce Daniel’s 2012 premium or provided as a cash payment) is not subject to federal employment taxes.
