IRS COBRA Audits Likely to Increase: How to Prepare

Employers who sponsor group health plans, take note.

If your business is subject to COBRA coverage (essentially all companies with more than 20 employees are), you could be the target of an Internal Revenue Service audit into your COBRA compliance.

Fortunately, earlier this year the IRS published revised guidelines for such audits, providing employers with valuable insight into the agency’s methodology and objectives. From law firm Ford & Harrison:

“Under the new guidelines, the IRS requires that any COBRA audit should at least consist of a review of the following: (i) the employer’s COBRA procedure manual (or its equivalent); (ii) form letters used by the employer in its COBRA administration; (iii) the underlying group health plan documents; (iv) the employer’s internal audit procedures; and (v) identification of, and details of, any COBRA-related litigation involving the employer.

For your reference, three takeaways from the new rules:

1. Employers should audit their own practices for compliance:

“Every employer who is subject to the COBRA excise tax should review their plan documentation to ensure it is current with applicable requirements, and establish or review their COBRA compliance procedures. They should train all personnel responsible for COBRA compliance on those procedures, and make sure that all aspects of their COBRA compliance program has been reviewed by counsel, that their COBRA premiums charged are supported by insurance premium data or actuarial calculations, and that they can support a good faith effort to comply with COBRA. Finally, employers should conduct periodic COBRA compliance audits using a well-designed COBRA audit manual or using the IRS Guidelines to monitor their COBRA compliance efforts.” (Littler)

2. The penalties for noncompliance can be steep:

“[The guidelines] set maximum amounts for penalties in cases of inadvertent violations (due to reasonable cause and not due to willful neglect):

(i) for single employer plans, the lesser of $500,000 or 10% of the employer’s total expenditure for the year on group health plans;

(ii) for multiemployer plans, the lesser of $500,000 or 10% of the plan’s total expenditure for the year on health care; and

(iii) for third parties, such as insurance companies or TPAs, $2,000,000 in the aggregate for all inadvertent failures during a taxable year.

If the person(s) responsible for the inadvertent failure become aware of the failure, and make no effort to correct it, the failure becomes one due to willful neglect, and the maximum limitations cease to apply.” (Ford & Harrison)

3. The best defense is a good offense:

“If the employer has effective COBRA procedures in place and follows them, it will be much easier to argue that any COBRA failures were due to reasonable cause and not willful neglect. Also, the IRS will take into account the taxpayer’s efforts to comply with COBRA in determining whether it will be appropriate to waive the excise tax in any given situation, by examining its COBRA compliance procedures, the training of personnel on those procedures, and the extent of the taxpayer’s use of competent professional counsel such as legal counsel and, where appropriate, actuarial advice, and the extent to which the COBRA program is updated to maintain compliance with current requirements.” (Littler)

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