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The 411 on De Minimis Fringe Benefits  (2003)

As an editor for Payroll Guide and an instructor for the CPP Review Class of my local APA chapter, I often get asked to answer perplexing payroll questions. With regard to de minimis fringe benefits, I hear these questions fairly often:

• "What is the limit on de minimis fringe benefits?" 

• "Is the limit on de minimis benefits $25?" 

• "Has the limit on de minimis fringe benefits recently been increased?"

Well, let's set the record straight. There is no limit on de minimis fringe benefits. By definition, a de minimis fringe benefit is any property or service offered so infrequently and the value of which is so small "as to make accounting for it unreasonable or administratively impracticable" [Code Sec. 132]. Once the value of a benefit has been calculated, it can no longer be considered de minimis. Consequently, cash provided to employees will never be considered de minimis, because the value of cash can always be determined and accounted for. If an employer provides Employee A with one penny, accounting for the benefit is not administratively impracticable. The employer knows who received the money and how much money was received. 

Putting a Price on It That, in a nutshell, is why there cannot be a limit on de minimis fringe benefits. If it can be accounted for, even a penny is too much. Most people believe that a de minimis fringe must have a value of no more than $25 to qualify. This is one of payroll's "urban legends," passed on from one payroll professional to another. Even if a fringe benefit's value is $25 or under, it is not considered de minimis if the taxable value can easily be determined in a calculation. 

This is not to say that an employer shouldn't monitor how much the value of a de minimis fringe benefit is. As the value of a benefit increases, the likelihood of it being considered de minimis decreases. For example, giving out candy canes to all your employees at the office holiday party would be considered a de minimis fringe. But, giving every employee a DVD player at the party would not be considered de minimis. It is not simply the value of the gift, however, that makes this unqualified for de minimis status. It is the fact that the employer most likely knows the value of the DVD players and knows who received a DVD player. With regard to the candy canes, it is likely that they came from a bag that contained many candy canes. While the price of the bag could be easily determined, it would be impracticable to calculate how much each candy cane was worth. 

The closest the IRS has come to putting a limit on a de minimis fringe is its decision in Chief Counsel Advice 200108042 that nonmonetary recognition awards having a fair market value of $100 do not qualify as de minimis fringe benefits and are considered wages subject to federal income tax withholding. The IRS did not specify what types of nonmonetary awards are at issue, and these administrative rulings are only applicable to the taxpayer directly addressed. Additionally, awards given in recognition for services performed are usually considered bonuses, subject to income and employment taxes. 

The IRS itself specifically allows for some more pricey items to be considered de minimis. Under IRS Reg 1.132-6(e)(1), occasional theater or sporting event tickets are excluded from an employee's gross income as a de minimis fringe benefit. Everyone knows these tickets can be very expensive depending on what show or sporting event it is. However, the IRS is not concerned with how much the ticket costs, but how often the same employee uses the tickets. Thus, the IRS does not consider season tickets to sporting or theatrical events to be de minimis.

Speaking of ... This leads to the question of frequency. For a benefit to be considered de minimis, it cannot be provided frequently. The frequency with which an employer provides similar fringe benefits to its employees generally is measured by how often the employer provides the benefits to each individual employee. For example, if an employer provides one employee with a free meal every day but not to any other employees, the benefit is not de minimis to the employee who receives the benefit. Going back to the discussion of sporting and theater tickets, if one employee receives tickets to more events than other employees, the benefit would not be de minimis to the employee who is receiving the most tickets. 

If it is difficult to measure how often an employer provides similar fringes to individual employees, the frequency is measured by how often it is provided to employees as a whole. As a result of this rule, a benefit could qualify as a de minimis fringe benefit to an employee even though he receives that benefit on a frequent basis. For example, an employee who uses a company copying machine for personal purposes several times a week would not be receiving a taxable fringe benefit if the copier was used far more frequently by company employees for business purposes.

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Domestic Partner Benefits: Taxing Questions (1997)

In the face of increasing numbers of nontraditional family relationships, more and more employers are offering group benefits to their employees' domestic partners and their children. This brings to the forefront, however, the tax consequences of offering such benefits to employees and the burden on payroll professionals in administering them. 

Tax-Free for Spouses and Dependents Generally, health insurance payments for the medical care of an employee, the employee's spouse, and the employee's dependents under a policy paid for by the employer are not includable in the gross income of the employee or other beneficiaries of the insurance and are exempt from FITW, FICA, and FUTA. Employer-provided coverage under an accident or health plan for personal injuries or sickness incurred by individuals other than the employee, his or her spouse, or his or her dependents, is not excludable from the employee's gross income and must be treated as wages for employment tax purposes

In determining if an individual is the spouse of an employee, employers traditionally looked to applicable state and local law. For example, an employee's domestic partner may have qualified as a spouse in a state that recognizes common-law marriages. A "dependent" is an individual over half of whose support is received from the employee, who has as his or her principal place of residence the home of the employee, who is a member of the employee's household, and who is related to the employee as a son, daughter, parent, grandparent, niece, nephew, uncle, aunt, or other specified relationship (see Code Sec. 152 ). However, an individual who meets the residence and support requirements may still fail to qualify as a dependent if the relationship between that person and the employee violates local law, such as in a residence state where unmarried cohabitation is not recognized.

Now, under the recently enacted Defense of Marriage Act ( P.L. 104-199 ), in interpreting any law of a United States agency, such as the IRS, the word "marriage" may mean only a legal union between one man and one woman as husband or wife, and a "spouse" is only a person of the opposite sex who is a husband or wife. Consequently, it is very unlikely that a same-sex partner or opposite-sex partner that is not a legal spouse would qualify for tax-free benefits under an employer-provided accident or health plan.

Benefits of the Benefits? There is no law that says employers cannot provide benefits to their employees' domestic partners and their dependents, regardless of the partner's gender. And, as stated above, more and more companies are doing so. However, if a domestic partner does not qualify as a spouse or a dependent, this coverage is a taxable fringe benefit to the employee even though the employee did not actually receive the benefit. The fair market value of the domestic partner's health insurance coverage over the amount paid for the employee's own coverage must be included in the employee's gross income as compensation for services and is subject to FITW, FICA, and FUTA. Consequently, employers will have to withhold additional amounts for federal income taxes and FICA taxes from the employee and pay an additional FICA contribution. Benefits paid for the domestic partner that are attributable to coverage which is included in the employee's income are not, however, taxable to the employee or the employee's domestic partner. 

The situation raises other issues as well. Employers offering flexible spending accounts must make sure employees do not submit their partners' medical expenses for reimbursement. Health plans under an FSA must conform to the IRC rules on health and accident insurance coverage to receive tax-favored treatment, including the definitions of spouse and dependent set forth above. Also, if an employee is terminated or has his or her hours reduced, a domestic partner may not be entitled to health care continuation under COBRA as a qualified beneficiary; COBRA also is subject to the definitions of marriage and spouse set forth in the Defense of Marriage Act.

Is this going to be an administrative burden on payroll? Probably not. According to a survey of 294 large U.S. companies by Towers Perrin, the 7% of the companies that offered domestic partner benefits reported an increase in medical claims of less than 1% after the coverage was made available. KPMG Peat Marwick's 1997 survey of employer's health care costs found that increases in employers' health care premiums were lower than the rate of inflation and the rise in wages, and the costs of coverage and premiums for firms offering and not offering domestic partner coverage were equivalent. To prevent any cost increase or administrative burden, some employers limit eligibility to either same-sex or opposite-sex partners, domestic partners who are in a "committed relationship" of a certain length of time, or a certain number of beneficiaries per employee. 

Despite a slight added burden, in this day and age, it seems sensible for employers to offer some form of domestic partner benefits. By supporting employees' differing needs and encouraging a diverse workplace, employers can stay competitive and bolster employee morale, without overburdening payroll departments.

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The Learning Curve (2002)

When the Economic Growth and Tax Relief Reconciliation Act of 2001 was signed into law, making the lRC§127 exclusion for employer-provided education "permanent," the payroll community cheered. However, the cheers died down when people realized that "permanent" under EGTRRA only meant permanent until 2010, when the provision would again expire. Collective, exasperated sighs of "here we go again" could be heard throughout the payroll community.

Since its inception in 1978, the exclusion has expired seven times and has been restored retroactively six times. Most recently, prior to the enactment of EGTRRA, the exclusion was set to expire Dec. 31, 2001 for courses beginning after May 31, 2000, but was extended under the Ticket to Work and Work Incentives Improvement Act of 1999 until Dec. 31, 2002. 

Usually when the exclusion lapsed, Congress adopted extensions on a retroactive basis. For example, after the benefit expired on June 30, 1992, it was retroactively extended under the Omnibus Budget Reconciliation Act of 1993 from July 1, 1992 through Dec. 31, 1994. Some payroll professionals considered what followed a nightmare. Employers that had included educational assistance in employee income from July 1992 to August 1993 (following the law) found themselves retroactively out of compliance and had to file corrected Forms W-2 and 941, reimburse employees for withheld Social Security and Medicare taxes, and in some cases had to file for refunds of FUTA taxes and contributions made to nonqualified plans and workers' compensation programs. Employees were also burdened with seeking reimbursements of federal income taxes on Forms 1040X. And let's not forget the state tax consequences. 

The exclusion again expired in January 1995, but was later reenacted retroactively under the Small Business Job Protection Act of 1996. Consequently, employers that had treated the educational benefits provided to employees as taxable wages in 1995, were entitled to refunds on FICA and FUTA taxes withheld and paid, and employees were entitled to FICA refunds directly from their employers and income tax refunds from the IRS. In an effort to avoid the nightmare of 1994, the IRS had set forth special procedures to expedite the process of refunding claims and ease some of the burden on employers. 

Although the provision is currently not set to expire for some years, let's take a look at what the IRS did in 1996 to ease the employers' burden.

  Employee Refunds Employers that taxed educational assistance as employee income after expiration of the §127 exclusion had to provide employees with Forms W-2c, Statement of Corrected Income and Tax Amounts, showing the correct wages for that year - the amount of wages indicated on the original Form W-2 less the amount of any qualified employer-provided educational assistance. Employees had to attach this form to Form 1040X, Amended U.S. Individual Income Tax Return , and file it with the IRS to obtain a refund of paid income taxes. The money was refunded directly to the employees. 

Employers had to reimburse their employees directly for FICA taxes withheld, through paychecks or separate payments. An employer that chose not to issue refunds to its employees had to provide employees with a statement that contained the amount that it had previously reimbursed the employee and any amount it claimed, or was authorized by the employee to claim. To compute the reimbursement correctly, employers had to review each employee's Social Security wage base to determine whether the employee was entitled to a refund of Social Security tax on the education assistance. Employers had to refund only Medicare tax to employees who were not entitled to a Social Security tax refund. Employer Refund To obtain their own FICA and FUTA refunds, employers had to report adjustments on Form 941, Employer's Quarterly Federal Tax Return, or Form 843, Claim for Refund and Request for Abatement. Employers also were required to file Form 941c, Supporting Statement to Correct Information, to explain the adjustments to Form 941.

  To expedite refunds, the Treasury waived the requirement that an employer obtain an employee's statement indicating the employee would not file duplicate refund claims. However, if the employer chose not to obtain such a statement, it was required to: (1) notify employees that it was claiming refunds on their behalf, make employees aware that they could not submit their own claims, and let employees know that it must be informed about any refund claims that the employees had already submitted; (2) refund overcollected taxes to employees for amounts that employees had not already claimed; and (3) indicate on Form 941c that the above had been done. 

Employers that reported employment taxes on forms other than Form 941, such as Form 843, were required to make adjustments on those forms and attach them to Form 941c. The employers had to print "IRC 127" in the top margin of the form to expedite their refunds. 

Although employers did get some administrative relief under the procedures, those employers that previously filed Forms W-2 had to provide employees with Forms W-2c, a paperwork burden that makes many in the payroll community unhappy. 

What the Future Might Hold Bills have been introduced to make the exclusion permanent. In May 2002, the House of Representatives went so far as to pass a bill removing the provision from EGTRRA that would sunset the tax provisions in 2010, thus permanently enacting the exclusion. Unfortunately, the bill didn't get any farther into Congress. Sen. Charles Grassley (R-Iowa) recently has introduced a bill that would make permanent some of the education tax incentives contained in EGTRRA, including the §127 exclusion.

  It's a wait-and-see game now. And, you've got time. We could still see two more presidents before 2010, each trying to make their mark by passing a big tax bill. And what better provision to attach to a big tax bill than the permanent extension of §127.

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Moving: Simple as 1, 2, 3 (2004)

Your company found a really great employee to take over for Jim in accounting, who retired this past winter. The new employee had to relocate from Oklahoma to New York and has submitted his moving expenses for reimbursement. Now your job is to figure out which expenses are taxable and which aren't and to report them correctly. He is married with two kids and a dog, he flew up a month before the rest of his family, he shipped up his cars, and he has submitted receipts for meals eaten during his and his family's trips. Don't worry. It's not as difficult as it appears. 

Step 1 First you must determine whether or not the expenses he submitted for reimbursement are qualified moving expenses. An employer's payment of moving expenses generally is treated as compensation that the employee must include in gross income, subject to federal income tax withholding, FICA, and FUTA. However, certain payments may be excluded from income if they meet the definition of "qualified moving expense reimbursements." Under IRC §217, qualified moving expenses are the reasonable expenses of moving household goods and personal effects (including packing, crating, and transporting, as well as in-transit storage for up to 30 consecutive days), and travel to the new home, including lodging but not including meals. If this had been a foreign move, there would be unlimited storage provided tax free. 

If it doesn't fit into one of those two categories, it is not a tax-free moving expense. Right off the bat, you can tell your new employee that the cost of meals that he and his family ate while traveling to their new home are not considered qualified moving expenses and will be subject to taxation.

What's that? Your company's relocation policy specifically allows meals as a reimbursable expense? Well, that's fine. You can still reimburse him for the meals he ate while traveling, but you must tax them. 

According to IRS Publication 521, 2003, other nondeductible moving expenses include: any part of the purchase price of the new home, expenses of buying or selling a home, home improvements made to help sell your home, mortgage penalties, real estate taxes, and temporary living expenses. 

Moving expenses for members of an employee's household may be excluded from gross income if they share both the old house and the new house with the employee. And, don't worry about Rover. The family pet is considered a member of the household.

Each member of the household gets one tax-free trip from the old home to the new home by direct route via conventional means. The trip for each family member can occur at separate times, so, the employee can relocate in advance of his family without changing the tax consequences of their trips. However, if the employee returns to the old home and then makes another trip to the new home with the rest of his family, his second trip is taxable.

Step 2 Next, you must determine if this is a qualified move. To be qualified, a move must satisfy the time test and the distance test. Under the time test, the employee must work for at least 39 weeks during the first 12 months after arriving in the general area of the new job location, though not necessarily 39 consecutive weeks. The employee doesn't even have to work for the same employer during that time as long as he is employed in the same general location. This refers to the general commuting area and is usually the same as the new place of residence. 

To satisfy the distance test, the new place of work must be at least 50 miles farther from the old residence than the distance between the former place of residence and former principal place of work. For example, if an employee's original commute was six miles from home to the old worksite, the employee's commute to the new worksite from the old residence must be at least 56 miles for moving expenses to qualify for nontaxable reimbursement. Since your employee moved from Oklahoma to New York, there should be no problem meeting this test.

Step 3 Once you've established that the move is qualified, you need to report the information on the employee's Form W-2. If the reimbursements to the employee are qualified moving expense reimbursements, you must report the amount of the payments, along with code "P," in box 12 on the employee's Form W-2. Any payments that do not qualify for exclusion from the employee's gross income must be reported as wages in boxes 1, 3, and 5 of the Form W-2. 

Don't worry if the payments to the moving company are paid by you directly to the moving company. Only those nontaxable payments made directly to the employee are reported in box 12 with code "P."

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Judicial Precedent: Case Closed? (2003)

As the payroll manager of your company, you try to keep up with the latest happenings in the payroll industry. As you read the latest issue of the Payroll Guide Newsletter over coffee one morning, your eye catches an article discussing the Supreme Court's recent decision in United States v. Fior d'Italia, holding that the IRS may assess employer FICA taxes based on an estimate of aggregate unreported tips. This is an issue your company deals with, so you read the article with interest. What does this mean for you as an employer? If the Supreme Court decided this, it's final, right? Maybe. 

Defining the Terms People seem to view judges as "supreme" beings, whose opinions are looked at as the final word on an issue. While judges and the court system as a whole are a very powerful institution, a court decision is not "the law." A court decision interprets the law as Congress has set it. 

What some court opinions do have is "precedent." Precedent is a legal principle that provides authority for judges to use in deciding similar issues. As a general rule, decisions of higher courts have precedent over lower courts within the same jurisdiction. For example, in California, decisions of the California Supreme Court are binding on all lower state courts, and decisions of the California Courts of Appeals are binding on all trial courts.

However, the decision of one state Court of Appeals is not binding on other Courts of Appeals. While the decision may be persuasive, it does not have to be followed by that other court. Generally, decisions of the U.S. Supreme Court are binding on all other courts in the United States.

Most payroll tax cases involving the IRS are brought in the United States Tax Court, which has jurisdiction to hear disputes concerning notices of deficiency, notices of transferee liability, certain types of declaratory judgment, readjustment and adjustment of partnership items, review of the failure to abate interest, worker classification, and to review certain collection actions.

Decisions of the Tax Court may be appealed to the proper circuit of the United States Court of Appeals. Some states also have their own tax courts. For example, in Oregon, the Tax Court has jurisdiction to hear tax appeals under state laws, including personal income tax, property tax, corporate excise tax, timber tax, local budget law, and property tax limitations. From there, decisions may be appealed directly to the State Supreme Court.

Case by Example The Eighth Circuit of the United States Court of Appeals recently decided in North Dakota State University v. United States that a university's early retirement payments to tenured faculty members were not subject to FICA withholding.

  The Eighth Circuit covers Arkansas, Iowa, Missouri, Minnesota, Nebraska, North Dakota, and South Dakota. However, once the decision came out, taxpayers from all over the country started filing refund claims with the IRS service center involved in that decision for FICA taxes withheld and paid by their employers. The IRS then advised service centers to only make FICA refunds to individuals that have claims concerning cases arising within the jurisdiction of the Eighth Circuit with the exact same facts.

How can the IRS do this? The Court of Appeals is one of the highest courts in the United States. Well, the IRS cannot limit the decision in lower courts in any of the states in the jurisdiction of the Eighth Circuit. But, courts in other states are not bound by that decision. Consequently, if a taxpayer brings a case in California with the same facts as in North Dakota University, the IRS can use the same arguments it used in the Eighth Circuit, and the court may reach a completely different decision. 

The Final Word? Prior to the Supreme Court's decision in Fior d'Italia, the Seventh, Eleventh, and Federal Circuits had decided in the IRS's favor on the issue of estimating aggregate tips. However, the Ninth Circuit and district courts in the District of Columbia and Florida had decided against the IRS.

It appears that the Supreme Court would be the last resting stop for disputes between taxpayers and the IRS. While that may be generally correct, the Court's decision in Fior d'Italia may not be a final victory for the IRS. According to Tracy Power, one of the attorney's who represented Fior d'Italia, the Court recognized problems with the IRS's methodology and invited the industry to challenge it on that score and to seek redress of its grievances in Congress, which has the power to change the law. The IRS's ability to use the authority given to it by the Court's decision may be limited, and the impact of the decision may not be that great.

  Additionally, cases are decided not based just on the law, but also on the facts. The same court can hear two cases dealing with the same principles of law, but with different facts, and come to two different conclusions. So the next time you read the casebook in the newsletter remember it may just be someone's opinion. 

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Case in Point

The payroll community breathed a collective sigh of relief recently when the Treasury Department decided to extend indefinitely the moratorium on imposing employment tax withholding upon the exercise of statutory stock options. Most found the decision a victory. However, some still fear (rightly so) that taxes will eventually apply to these options. 

Is this the first step in withdrawing proposed IRS regs that would apply employment taxes to the exercise of stock options, or is this just delaying the inevitable? And, if the IRS does start imposing employment taxes on stock options, is there any recourse for the payroll community? 

What Are the Chances? The Treasury Department's own language when announcing the extension leads to only one conclusion: It is just delaying the imposition of taxes on stock options. Pam Olson, acting assistant secretary of tax policy, is quoted as saying, "given the significant administrative changes that would be required of employers to implement the proposed withholding, it is clear that a delay in the effective date is necessary to provide employers with adequate time to make the required changes." 

Additionally, the IRS has had a recent policy of holding in private letter rulings that FICA and FUTA is incurred at the time an option is exercised in an amount equal to the excess of the value of the stock on that date over the option price. 

All hope is not lost, however. Testifying at a hearing on the proposed IRS regs, Scott Mezistrano, manager of government relations for the American Payroll Association, and Mary B. Hevener, of Baker & McKenzie, both argued that if the IRS insists on taxing statutory options, taxpayers will probably file suit in the Court of Federal Claims to stop the Service from enforcing the regulations. In 1991, the court ruled in Anderson v. United States [16 Cl. Ct. 530 (Cl. Ct. 1989) aff'd 929 F.2d 648 (Fed. Cir. 1991)] that amounts are not FICA wages if they are not first income. This decision was affirmed by the Federal Circuit Court. 

Just the Facts In Anderson , the court ruled that amendments to the IRC, made by the Deficit Reduction Act of 1984 (DRA), did not subject previously nontaxable payments for living quarters and temporary lodging, paid under the Overseas Differentials and Allowances Act (ODAA), to taxation under FICA. 

Civilian teachers employed by the Department of Defense at the United States Naval Air Station in Bermuda from 1984 through 1987 received certain payments called "living quarter allowances" and "temporary lodging allowances" under the ODAA for lodging costs incurred on overseas housing in Bermuda. By statute, ODAA allowances have always been excluded from "gross income," and, thus, exempt from income tax. When FICA was extended to certain government employees in 1983, the Navy began including ODAA payments in the base for FICA taxes.

  In 1984, the Deficit Reduction Act amended the definition of "compensation for services" to include fringe benefits, unless specifically excluded under IRC §132. The act also amended the income tax withholding provisions requiring employers to withhold income taxes from employees' wages, including benefits. In Anderson , the government relied on these amendments to argue that ODAA payments, which remained excluded from income for income tax purposes, were silently made subject to FICA taxes by the DRA since there is no specific exclusion for such payments under IRC §132.

  The court disagreed with the government, finding that nothing in the DRA changed FICA tax treatment of ODAA payments, which the government conceded were not subject to FICA before the DRA was enacted. Additionally, ODAA payments are specifically excluded from gross income under IRC §61. Thus, while the government's position that "fringe benefits" are taxable under FICA unless they fall under IRC §132 may well have validity in the context of considering other fringe benefits, such benefits, unlike ODAA payments, were first made part of "gross income." 

The Bottom Line So, what about stock options? IRC §421(a)(1) specifically states "no income shall result at the time of the transfer of such share to the individual upon his exercise of the option with respect to such share." The Code is silent regarding whether the exercise of stock options is wages subject to FICA. Under IRC §61, wages are considered income. Can there be wages for employment tax purposes if there is no income? According to Anderson, the answer is no. Amounts are not FICA wages if they are not income. 

If the proposed regs do eventually go into effect, and taxpayers do bring suit against the Treasury Department and the IRS, the Court of Federal Claims could very well decide, as in Anderson that FICA taxes should not be imposed on amounts that are not income. According to Hevener, if the Federal Circuit affirms this decision, the IRS would have to refund any FICA and FUTA taxes paid. It wouldn't want to do that, would it? 

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National Eye Health Education Program Outlook Newsletter

Outlook Archive (Fall 2011 - Fall 2018)

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Clinical Trials and Social Media Workshop, June 2018

Executive Summary 

Workshop Summary

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Sponsors Face Many Risk Areas in Delegating Part D Duties to PBMs, Other Subcontractors

Part D plans need to pay close attention to the functions they have delegated to pharmacy benefit managers (PBMs) and other subcontractors because, during audits, CMS will hold plan sponsors responsible for problems regardless of whether it is  first-tier or downstream entities causing those problems. This also applies to plans that own and operate their own PBMs.

In fact, these plans may face more scrutiny from CMS, said Dorothy DeAngelis, managing director at Huron Consulting Group. DeAngelis and Richard Merino, a manager at Huron, noted that CMS has started auditing Part D plans. And the agency is focusing on areas routinely delegated to PBMs and other outside contractors.

For example, Merino told listeners at an Aug. 14 Webinar sponsored by Financial Research Associates that one “key area” CMS is focusing on in audits is sales and marketing.

This “stems back to delegation oversight” of brokers and agents, he said. In setting up an oversight program, marketing is essential, he added. Unfortunately, many oversight programs focus on training but fall down with ongoing review, noted Merino, such as utilizing the “secret shopper,” in which a staffer pretends to be a customer and attends an enrollment seminar or other plan-sponsored event to hear what sales agents are saying about the plans.

Other areas CMS is focusing on in audits include coordination of benefits and long-term care. LTC is a “hot button issue” in audits, said DeAngelis, with CMS looking at the ratios of LTC pharmacies to regular retail pharmacies. If LTC is a delegated function, the contractor should fill out access forms to show sufficient access on an ongoing basis, she recommended.

Merino highlighted the importance of making a clear distinction between auditing and monitoring. He explained that “auditing is a retrospective review against internal or external CMS standards,” while “monitoring is an ongoing review of performance standards.”

Oversight programs “should incorporate both,” Merino suggested, because “having one or the other may not give the coverage needed in an oversight program.” CMS expects plan sponsors to have established programs “allowing ongoing audits and reviews of delegates,” he added.

One of the most important delegated relationships is that between the plan and the PBM. Commonly delegated functions include formulary management, pharmacy network maintenance, claims pricing, rebate administration, and utilization management. And the key to making this relationship successful is in the contract between the plan and the PBM, said Merino. What is contained in the contractual relationship is “vitally important” to know, he said.

Merino explained that CMS actually requires certain provisions to be included in the contract with regard to what the delegate (in this case the PBM) actually gets a contract to do. For example, the contract must include clear descriptions of what services have been delegated and the reporting responsibilities, the ongoing monitoring that the plan will perform, and the provision for revocation of the delegation if the delegate has not performed satisfactorily.

DeAngelis said that Huron often finds that no two contracts are the same, and most don’t allow for proper auditing and monitoring. Unfortunately, plans don’t find this out until they try to invoke their audit rights against the PBM, she added. 

For example, DeAngelis said that pricing arrangements, rebate percentages, and administrative costs may be included in contracts and should be carefully reviewed to make sure there is full cost disclosure. She called this “where the rubber meets the road.”

There is no regulatory or statutory definition of Average Wholesale Price (AWP), she said, and the compendia source and publisher, First DataBank, won’t list the AWP for 2009. With the possible move to Wholesale Average Cost (WAC), it is important for contracts to set forth how the AWP is determined — either through the compendia source, the average annual aggregate by drug class, or some other way.

With regard to rebates, DeAngelis said that contracts are sometimes ill-defined and a “historical source of dissatisfaction for plan sponsors.” Rebates occur after the point of sale and, as such, can be assessed only with an audit, usually by an outside entity, she said.

Moreover, the terms are usually between the PBM and the drug manufacturer, and the contract will specify how the manufacturer wants to receive claims data. But there is sometimes a submissions lag of three to six months for claims data, and many PBMs won’t allocate rebates to plans until they get paid, DeAngelis explained.

Adding to the stress is the fact that it is “almost impossible to know what are in agreements remotely” regarding rebates, she said, and PBMs usually won’t let the agreements go off site.

Most contracts between plans and PBMs have audit clauses, but DeAngelis argued that they are “rarely specific enough.” Some things just aren’t accounted for, she said. Most plans historically have done claims and rebate reviews but haven’t done operational or clinical reviews. DeAngelis advocated focusing on Part D administrative functions as well as financial functions. Plans also shouldn’t forget about specialty pharmacy issues such as home infusion and long-term care, she warned.

Risky Business

There are some risk areas in delegating duties to a PBM or other subcontractor that plans need to watch out for, said Merino. For example, Part D sponsors make certain attestations that information provided to CMS is true and accurate, including attestations about Prescription Drug Event (PDE) data and true out-of-pocket (TrOOP) expenses. PDE and TrOOP data that come from PBMs form the basis of these attestations, explained Merino. 

As attestations are “exceedingly important,” it is also important to know how the data are produced and what source the data come from, he suggested. There is “large liability” on the side of the sponsor if the attestations are inaccurate, Merino warned. He advised plans to be prepared to audit and validate that the information and data generated and reported by the PBM for these attestations is accurate. Plans should include the right to audit and validate the data in the PBM agreement, he added.

Other risk areas include claims pricing and PDE reconciliation. The way PBMs price drugs is an essential element of PDE data and the basis for plan reimbursement.

It is important for plans to know they are getting correct pricing based on contractual obligations and to make sure pass-through pricing is being calculated correctly, Merino said.

Plans should establish ways to audit their PBMs to ensure they are complying, such as electronic review of claims or detailed testing audits, recommended Merino. With electronic reviews, plans can reprice their claims history and make sure the PBM is applying the correct drug unit pricing and other formulas, he explained. It allows plans to review 100% of claims over a certain amount of time, Merino added.

Detailed testing consists of audits of random samples of claims. According to Merino,  this allows plans to do “more detailed testing on a claim-by-claim basis,” looking for duplicate claims, correct dispensing fees, and formulary compliance, among other things.

Another risk area is coverage determinations and appeals. Since this is typically a health plan function, PBMs have less experience dealing with issues that can arise — which have increased under the Part D program, he said, calling it a “difficult challenge for  many” PBMs. Plans need to make sure testing of actual cases occurs on an ongoing basis, using CMS audit tools, he suggested.

Merino said that plans have been slow to act on this front, and Huron has seen a “lack of documentation” in case files of prior authorizations and coverage determinations. Another problem he identified is the “tight time frames” for notices and determinations.

A major risk area identified by Merino is the pharmacy audit. This is generally a function of the PBM that has been “overlooked up to now,” he said. It is essential that a plan becomes aware of how the PBM audits network pharmacies and makes sure no fraud exists in that network, he stressed.

Pharmacy audits can be desk audits, field audits, or electronic reviews. But no matter what type of audit is conducted, plans must make sure they cover a majority of the Part D pharmacies included in the network, including long-term care and home infusion pharmacies, Merino said.

Mind Your P&Ps

In addition to looking at the data, Merino advised plans to look also at the “operation of the PBM.” How a PBM administers a Part D program can usually be found in its policies and procedures (P&Ps) documentation, he said. Plans should review this documentation and make sure it complies with CMS requirements. If the actual operations are not consistent with the operational policies, and the policies are not “followed on a day-to-day basis,” Merino said that is a “big discrepancy that must be rooted out.” “CMS wants to see that you know what’s going on with your PBM,” he said.

According to DeAngelis, there have been a lot of audits in this area, and early feedback indicates that plans “need to place more emphasis on policies and procedures.” She described one plan as simply packaging the P&Ps of the PBM and giving that to CMS during an audit. The agency wanted to know if the plan actually oversaw the PBM, she said.

Merino warned plans not to focus exclusively on P&Ps, though. Now, he explained, coordination-of-benefits (COB) audits focus on P&Ps. But there will be “more detailed auditing of transactions in the future, and the effect of COB on TrOOP and PDE will be audited,” he said. This effect is “vitally important to CMS in an audit environment,” he said.

DeAngelis said that plans have been slow to get out there and audit their PBMs and other contractors, but with Part D audits having started, it is imperative that sponsors get moving. She recommended that plans submit to PBMs a robust request for proposal in the first place. Then she advised plans to make a site visit to the PBM before any delegation of duties. “Prevention is obviously the best medicine,” she said.