IRS Puts COBRA Under Scrutiny: Consider a Self Audit or Pay the Price

Jeremy Sharp is a partner with the law firm Walter & Haverfield in Cleveland.
Jeremy Sharp is a partner with the law firm Walter & Haverfield in Cleveland.

By Jeremy J. Sharp

Employers beware: The Internal Revenue Service recently issued new revised audit guidelines for IRS auditors who review group health plans for COBRA compliance in the aftermath of a 10-year task force study. And, this review could end up being costly for your company if an IRS auditor should come knocking on your door.

Industry commentators feel these revised guidelines likely will trigger an increased audit emphasis by the IRS in respect to COBRA compliance. Chances are, if audited, most employers will have some sort of COBRA failure, inadvertent or otherwise. And, even if a compliance failure is unintentional, you still risk incurring stiff penalties.

For example, Section 4980B of the Internal Revenue Code imposes an excise tax for failure to comply with COBRA continuation coverage obligations and requirements. The $100 excise tax is assessed for each qualified beneficiary for whom the failure occurs, with a maximum of $200 per family.

IRS penalties can be costly

The excise tax is assessed daily for each day an employer is in the “noncompliance period.” This is the period begins on the day of failure and ends on the day of correction, or, if earlier, six months after the last day of the applicable COBRA maximum coverage period.

It can get costly. Let’s say you completely failed to give notice of COBRA enrollment rights to three families following a termination of employment, for which the COBRA maximum coverage period is 18 months. You could face a potential excise tax penalty of $438,000. This total is derived from $200/family x 3 families x 24 months (18 months plus six months).

The revised guidelines also outline minimum and maximum penalties. For failures not corrected before the date that the IRS sends you a notice of examination and that continue during the examination period, the minimum penalty for de minimis (not significant) is $2,500 for each beneficiary.

The minimum for failures that are NOT de minimis is $15,000 for each qualified beneficiary. For a single employer plan, the maximum penalty for failures in any given taxable year discovered during an IRS audit are $500,000 or, if less, 10 percent of the employer’s total expenditures on the group health plan for the year.

For inadvertent failures, as many likely will be, the noncompliance period does not begin until the responsible person knew or should have known of the failure to comply. If the failure occurs from reasonable cause and not willful neglect, you could be granted a 30-day grace period following discovery of the failure. You can use this time to correct the violation without having to pay the excise tax. This tax, by the way, is not deductible for tax purposes.

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How a proactive, self-audit would work

With this in mind, it’s better to take the proactive route and perform a self audit with the help of trusted counsel to discover any compliance issues that would be found during an IRS COBRA compliance audit and correct any violations that you might discover in the process. To give you a better idea of what to look for in your own audit, here’s a snapshot of what IRS auditors will examine during one of their own COBRA compliance audits.

During an audit, IRS auditors will conduct interviews with appropriate staff members regarding the number of COBRA qualifying events occurring in the year under examination through the current day. They’ll also inquire about the methods your company uses to notify beneficiaries of COBRA continuation rights, as well as the method the plan administrator is notified of a qualifying event. Also likely to be discussed are the elections made and the premiums paid by qualifying beneficiaries to continue health coverage.

They also will examine your COBRA continuation coverage compliance procedures manual, standard COBRA coverage form letters and notices, group health plan documents and also any detail regarding past or pending lawsuits in respect to your company’s COBRA obligations. All of these are standard documentation that IRS auditors would scrutinize during the audit process.

Auditors might also ask to see copies of your federal and state employment tax returns for the period under examination and the preceding year, as well as lists of all individuals affected by qualifying events during the current year and also those covered on the first day and the last day of the current and preceding year, including employees, spouses and dependent children. Personnel records might also come under review with respect to COBRA qualifying events, notices, reasons for termination of employment and COBRA continuation coverage, and premium and coverage information.

When performing a self audit, pay attention to all of these materials and be sure to amend any plan documents, policies and procedures so that you eliminate any compliance gaps. Also ensure that all information necessary to respond to IRS information requests are up to date and readily available and that responsibilities for COBRA obligations are clearly delineated and assigned.

All of this will minimize the risk of noncompliance going forward and keep costly audit-generated penalties at bay.

Jeremy Sharp, a partner at Walter & Haverfield in Cleveland, concentrates his practice primarily in the field of employee benefits and executive compensation. He also has experience handling related legal issues involving taxation, labor and employment law, school law and health care reform. You can contact him at