* * * * *

(c) Effective date. This part 300 is applicable March 16, 1995, except that the user fee for processing offers in compromise is applicable November 1, 2003; the user fee for the special enrollment examination, enrollment, and renewal of enrollment for enrolled agents is applicable November 6, 2006; the user fee for entering into installment agreements on or after January 1, 2007, is applicable January 1, 2007; and the user fee for restructuring or reinstatement of an installment agreement on or after January 1, 2007, is applicable January 1, 2007.

Par. 3. Section 300.1 is amended by revising paragraph (b) to read as follows:

* * * * *

(b) Fee. The fee for entering into an installment agreement before January 1, 2007, is $43. The fee for entering into an installment agreement on or after January 1, 2007, is $105, except that:

(1) The fee is $52 when the taxpayer pays by way of a direct debit from the taxpayer’s bank account; and

(2) Notwithstanding the method of payment, the fee is $43 if the taxpayer is a low-income taxpayer, that is, an individual who falls at or below 250% of the dollar criteria established by the poverty guidelines updated annually in the Federal Register by the U.S. Department of Health and Human Services under authority of section 673(2) of the Omnibus Budget Reconciliation Act of 1981 (95 Stat. 357, 511), or such other measure that is adopted by the Secretary.

* * * * *

Par. 4. Section 300.2 is amended by revising paragraph (b) to read as follows:

* * * * *

(b) Fee. The fee for restructuring or reinstating an installment agreement before January 1, 2007, is $24. The fee for restructuring or reinstating an installment agreement on or after January 1, 2007, is $45.

* * * * *

Kevin M. Brown,
Acting Deputy Commissioner for
Services and Enforcement.

Approved December 21, 2006.

Eric Solomon,
Assistant Secretary
of the Treasury (Tax Policy).

The IRS and Treasury Department are publishing temporary regulations under section 1561 for several reasons. First, the current regulations are outdated in that they refer to tax benefit items that are no longer listed in section 1561(a). Except as provided below, to minimize this issue in the future, the temporary regulations refer generically to the tax benefit items listed in section 1561(a) rather than refer specifically to those items by listing and describing each one.

Second, the current regulations do not provide guidance to taxpayers regarding how to allocate the amounts of the section 1561(a) tax benefit items among the component members of a controlled group of corporations which have an apportionment plan in effect. As a result, the IRS often can not determine whether taxpayers have correctly allocated these items. Thus, the temporary regulations refer to a new form (i.e., Schedule O or any successor to that form) on which such members will provide information about these items.

Except as provided below, each component member of a controlled group must file this form every year with its Federal income tax return whether or not: (1) an apportionment plan is in effect, or (2) any change is made to the group’s apportionment of its section 1561(a) tax benefit items from the previous year. However, whenever one or more of the component members of a controlled group of corporations are also members of a consolidated group, the parent of such consolidated group shall file one form on behalf of all of its members. That form shall contain all the information required for each such member.

Finally, §1.1561-3(b) presents an impediment to e-filing where such members have consented to the adoption of an apportionment plan. That section requires each member of a controlled group to attach to its return, for each year following the adoption of the plan, a copy of its signed consent to such plan. As explained in T.D. 9264, that signature requirement presents an impediment to e-filing. These temporary regulations eliminate this impediment and provide that the form will be the mechanism by which such member adopts (and also amend or terminate) such plan. Thus, each member of the group (that is not a member of a consolidated group) will file this form to consent to adopt a plan, even if it is a wholly-owned subsidiary of the group. Compare §1.1561-3(b)(2)(i) (a wholly-owned subsidiary of a controlled group was not required to consent to adopt a plan because it was deemed to consent if all the component members of that group that are not wholly owned subsidiaries consent). Thus, these temporary regulations eliminate the deemed consent provision of §1.1561-3(b)(2)(i).

Section 1561(a) provides that the component members of a controlled group of corporations must divide the amount of the accumulated earnings credit (the credit) equally unless the Secretary prescribes regulations permitting an unequal allocation of that amount. However, §1.1561-2(c) requires that they divide that amount equally. The IRS and Treasury Department have concluded that they no longer will require such members to divide that amount equally. Therefore, these temporary regulations now provide that the component members of a controlled group may choose to allocate the amount of that credit unequally among themselves if they have an apportionment plan in effect.

For the sake of consistency, the IRS and Treasury Department are reformatting §1.1563-1 to conform it to current formatting conventions. It is not intended that any such reformatting constitute a substantive change. Moreover, the changes described in this paragraph of the preamble are only limited to formatting. Thus, for example, except for the changes described below, no examples in §1.1563-1 have been updated to reflect current law. Such changes are beyond the scope of this project and will be addressed in a separate regulation project.

Section 900 of the American Jobs Creation Act of 2004, Pub. L. 108-357, 118 Stat. 1418 (the 2004 amendment), revised the definition of a brother-sister controlled group in section 1563(a)(2). Prior to this 2004 amendment, commonly owned corporations qualified as a brother-sister controlled group if five or fewer persons who are individuals, estates, or trusts own (within the meaning of section 1563(d)(2)) stock possessing: (A) at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of each corporation (the 80 percent requirement) and (B) more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock of each corporation, taking into account the stock ownership of each such person only to the extent such stock ownership is identical with respect to each such corporation (the more-than-50 percent requirement).

The 2004 amendment eliminated the 80 percent requirement from the section 1563(a)(2) definition of a brother-sister controlled group. As a result, for purposes of section 1561, corporations are component members of a brother-sister controlled group if just the more-than-50 percent requirement is satisfied. However, for all other provisions of law that incorporate the section 1563(a) definition of a brother-sister controlled group, both the more-than-50 percent requirement and the 80 percent requirement must be satisfied in order to qualify as a brother-sister controlled group. See section 1563(f)(5). Therefore, these temporary regulations reflect this change.

These temporary regulations apply to tax years beginning on or after the date they are published in the Federal Register. However, the above described 2004 amendment to section 1563(a)(2) is effective for tax years beginning after October 22, 2004.

Section 1.1561-1(c)(1) provides that, for purposes of sections 1561 and 1563, the term corporation includes an electing small business corporation and refers to §1.1563-1(b)(2)(ii)(c) for the treatment of such a corporation as an excluded member of a controlled group of corporations. Specifically, §1.1563-1(b)(2)(ii)(c) provides that only an electing small business corporation which is not subject to the tax imposed by section 1378 will be treated as an excluded member.

Section 1378, as in effect when §1.1563-1(b)(2)(ii)(c) was published (old section 1378), taxed the income of an electing small business corporation if its income exceeded a certain threshold. That income was taxed at the lower of the rate determined under section 1201(a) or section 11. Thus, when such corporation was subject to tax under section 11, it was appropriate to treat such corporation as a component member of a controlled group for purposes of allocating its section 11 tax benefit amount.

Old section 1378 was ultimately repealed as part of the Tax Reform Act of 1986 (Pub. L. 99-514, 100 Stat. 2085). Thus, §1.1563-1(b)(2)(ii)(c) became obsolete.

Under current law, an S corporation (the successor to an electing small business corporation) is generally subject to tax at the entity level under only two provisions: (1) section 1374, which imposes tax on certain recognized built-in gain, and (2) section 1375, which imposes tax on passive investment income under certain circumstances. However, in both cases, the amount of tax imposed on an S corporation is computed by applying the highest rate of tax specified in section 11(b). See sections 1374(b)(1) and 1375(a). Thus, under either of these provisions, no portion of any of the lower tax bracket amounts of section 11(b) could be allocated to such a corporation.

In other instances, an S corporation is partially liable for taxes that were imposed on the income of its predecessor C corporation that it must now recapture. See, e.g., sections 167(g), 460(b), 1363(d) and 1371(d)(2). However, these recapture taxes are not being imposed on an S corporation’s own income.

Since an S corporation is not currently subject to any tax to which either the tax bracket amounts of section 11(b) apply, or any other tax benefit item to which section 1561(a) applies, it is appropriate to treat that corporation as an excluded member of a controlled group.

These temporary regulations clarify that only to the extent that a particular tax (and thus a particular tax benefit item to which section 1561(a)) applies to an S corporation is that type of corporation treated as a component member of the group. This general reference to a tax that applies to an S corporation is intended to avoid the issue in §1.1563-1(b)(2)(ii)(c) of referring to a particular Code section that later became obsolete (i.e., old section 1378).

The current regulations under section 1563 describe the treatment of life insurance companies under the controlled group rules. Section 1.1563-1(a)(5) provides that two or more life insurance companies that are members of a controlled group are treated as a distinct controlled group of corporations composed only of life insurance companies. Section 1.1563-1(b)(2)(ii)(e) defines a life insurance company as an excluded member unless that type of company is a member of a separate life insurance company controlled group described in §1.1563-1(a)(5).

Section 1504(c)(2) provides that if an affiliated group includes any domestic life insurance companies that would otherwise not be treated as includible members of the group, then, except as provided therein, the common parent of such group may elect (pursuant to regulations prescribed by the Secretary) to treat all such companies as includible corporations. Paragraph (f)(6) of §1.1502-47 implements section 1504(c)(2) as it relates to section 1563.

These temporary regulations provide that if one or more life insurance companies are members (whether eligible or ineligible) of an affiliated group for the consolidated return year for which a section 1504(c)(2) election is effective, then those members are not treated as either excluded members of the controlled group or as members of a separate life insurance controlled group. See §1.1502-47(f)(6). Rather, any eligible members are treated as members of the consolidated group, and any ineligible members are treated, along with the eligible and includible members of the consolidated group, as members of a life-nonlife controlled group.

These temporary regulations apply to tax years beginning on or after the date they are published in the Federal Register. However, paragraph (f)(6) of §1.1502-47 applies to tax years of consolidated groups beginning on or after January 1, 1982. See T.D. 7877, 1983-1 C.B. 207.

Section 1.1502-43 provides rules for calculating the consolidated accumulated earnings tax. Section 1.1502-43(d) is currently reserved. These temporary regulations clarify that if the consolidated group is part of a controlled group then section 1561 applies in determining the amount of that credit.

These temporary regulations apply to consolidated return years for which a return is due (without extensions) after the date it is published in the Federal Register. However, pursuant to the Tax Reform Act of 1969, Pub. L. 91-172, 78 Stat. 116, the accumulated earnings credit became a full tax benefit item under section 1561(a) for tax years beginning after December 31, 1974.

Section 1.1502-47 provides rules for a life-nonlife consolidated group to calculate its consolidated taxable income. Paragraph (s) of §1.1502-47 requires a consolidated group to provide a notation on the face of its return identifying it as a life-nonlife return. This requirement presents an impediment to e-filing. These temporary regulations remove the impediment by deleting the requirement to provide that notation.

As part of this Treasury decision, the IRS and Treasury Department are deleting numerous obsolete regulations. This effort is part of an ongoing process to remove those types of regulations from the Code of Federal Regulations (the CFR). Therefore, the following regulations are deleted from the CFR: §§1.342-1, 1.371-1 through 1.371-2, 1.372-1, 1.374-1 through 1.374-4, 1.1018-1, 1.1562-0 through 1.1562-7, 1.1564-1 and 5.1561-1.

* * * * *

(d) [Reserved]. For further guidance, see §1.1502-43T(d).

(e) [Reserved]. For further guidance, see §1.1502-43T(e)(1).

Par. 13. Section 1.1502-43T is added to read as follows:

(a) through (c) [Reserved]. For further guidance, see §1.1502-43(a) through (c).

(d) Consolidated accumulated earnings credit— (1) In general. [Reserved]

(2) Special rule if consolidated group part of controlled group. If a consolidated group is treated as a component member of a controlled group, or if each member of a consolidated group is treated as a component member of a controlled group, see section 1561 for determining the portion of the accumulated earnings credit to be allocated to such group or to such members.

(e) Effective date— (1) Applicability date. This section applies to any consolidated Federal income tax return due (without extensions) after December 22, 2006. However, a consolidated group may apply this section to any consolidated Federal income tax return filed on or after December 22, 2006.

(2) Expiration date. The applicability of this section will expire on December 21, 2009.

Par. 14. Section 1.1502-47 is amended by revising paragraph (s) and adding paragraph (t) to read as follows:

* * * * *

(s) [Reserved]. For further guidance, see §1.1502-47T(s).

(t) [Reserved]. For further guidance, see §1.1502-47T(t)(1).

Par. 15. Section 1.1502-47T is amended by revising paragraph (s) and adding paragraph (t) to read as follows:

* * * * *

(s) Filing requirements. Nonlife consolidated taxable income or loss under paragraph (h) of §1.1502-47 shall be determined on a separate Form 1120 or 1120-PC, and consolidated partial LICTI under paragraph (j) of §1.1502-47 shall be determined on a separate Form 1120-L. The consolidated return shall be made on a separate Form 1120, 1120-PC, or 1120-L filed by the common parent (if the group includes a life company), which shows the set-offs under paragraphs (g), (m), and (n) of §1.1502-47 and clearly indicates on the face of the return that it is a life-nonlife consolidated return (if the group includes a life company). See also §1.1502-75(j), relating to statements and schedules for subsidiaries.

(t) Effective date— (1) Applicability date. Paragraph (s) of this section applies to any consolidated Federal income tax return due (without extensions) after December 22, 2006. However, a consolidated group may apply paragraph (s) of this section to any consolidated Federal income tax return filed on or after December 22, 2006.

(2) Expiration date. The applicability of paragraph (s) of this section will expire on December 21, 2009.

Par. 16. Section 1.1502-90 is amended by:

1. Removing and reserving the entry for §1.1502-95(e)(8).

2. Removing and reserving the entry for §1.1502-95(f).

3. Reserving an entry for §1.1502-95(g).

4. Adding entries for §1.1502-95T.

The additions read as follows:

* * * * *

* * * * *

(g) [Reserved]

(a) through (e)(7) [Reserved]

(e)(8) Reporting requirements.

(i) Common Parent.

(ii) Former Member.

(iii) Exception.

(f) Filing the election to apportion the section 382 limitation and net unrealized built-in gain.

(1) Form of the election to apportion.

(i) Statement.

(ii) Agreement.

(2) Signing the agreement.

(3) Filing of the election.

(i) Filing by the common parent.

(ii) Filing by the former member.

(4) Revocation of election.

(g) Effective date.

(1) Applicability date.

(2) Expiration date.

(a) In general. (1) Part II (section 1561 and following) of subchapter B of chapter 6 of the Internal Revenue Code (part II) provides rules to limit the amounts of certain specified tax benefit items of component members of a controlled group of corporations on a December 31, for their taxable years which include such December 31. The component members of such a group shall be limited for purposes of subtitle A of the Code to the amounts of certain items, set forth in section 1561(a), as if they were one corporation. Certain other tax items also set forth in section 1561(a) (e.g., the additional tax imposed by section 11(b)(1) and the section 55(d)(3) phase out of the alternative minimum tax exemption amount) will be determined by combining the taxable income of all such members and then allocating the amount of such items among such members.

(2) For certain definitions (including the definition of a controlled group of corporations and a component member) and special rules for purposes of this part II, see section 1563.

(b) Special rules. (1) For purposes of this part II, the term corporation includes a small business corporation (as defined in section 1361). However, for the treatment of such a corporation as an excluded member of a controlled group of corporations see §1.1563-1(b)(2)(ii)(C).

(2) In the case of corporations electing a 52-53-week taxable year under section 441(f)(1), the provisions of this part II shall be applied in accordance with the special rule of section 441(f)(2)(A). See §1.441-2.

(c) Tax avoidance. The provisions of this part II do not delimit or abrogate any principle of law established by judicial decision, or any existing provisions of the Code, such as sections 269, 482, and 1551, which have the effect of preventing the avoidance or evasion of income taxes.

(d) Effective date— (1) Applicability date. This section applies to any taxable year beginning on or after December 22, 2006. However, taxpayers may apply this section to any Federal income tax return filed on or after December 22, 2006.

(2) Expiration date. The applicability of this section will expire on December 21, 2009.

Par. 20. Section 1.1561-2 is amended by removing and reserving paragraphs (a) and (b), revising paragraph (c), removing and reserving paragraph (d) and adding paragraph (f) to read as follows:

* * * * *

(c) [Reserved]. For further guidance, see §1.1561-2T(c).

* * * * *

(f) [Reserved]. For further guidance, see §1.1561-2T(f)(1).

Par. 21. Section 1.1561-2T is added to read as follows:

(a) through (b) [Reserved]

(c) Accumulated earnings credit. The component members of a controlled group of corporations may allocate the amount of the accumulated earnings credit unequally if they have an apportionment plan in effect.

(d) [Reserved]

(e) [Reserved]. For further guidance, see §1.1561-2(e).

(f) Effective date— (1) Applicability date. This section applies to any taxable year beginning on or after December 22, 2006. However, taxpayers may apply this section to any Federal income tax return filed on or after December 22, 2006.

(2) Expiration date. The applicability of this section will expire on December 21, 2009.

Par. 22. Section 1.1561-3 is removed.

Par. 23. Section 1.1561-3T is added to read as follows:

(a) Filing of form— (1) In general. For each taxable year that a corporation is a component member of the same controlled group of corporations on a December 31, for its taxable year that includes such December 31, such corporation and all other component members of such group must each file the required form (i.e., Schedule O or any successor to that form) with each Federal income tax return. Each such corporation must file that form with its return whether or not—

(i) An apportionment plan is in effect; or

(ii) Any change is made in the group’s apportionment of its section 1561(a) tax benefit items from the previous year.

(2) Exception for component members that are members of a consolidated group. If one or more of the component members of a controlled group of corporations are also members of a consolidated group, the parent of such consolidated group shall file only one form on behalf of all of such members. Such form shall contain the information required for each such member.

(b) No apportionment plan in effect. If the component members of a controlled group of corporations do not have an apportionment plan in effect, the amounts of the section 1561(a) items must be divided equally among all such members. For purposes of the preceding sentence, if any component members of a controlled group of corporations are also members of a consolidated group, such members will each be treated as a separate component member of the controlled group.

(c) Apportionment plan in effect— (1) Adoption of plan. The component members of a controlled group of corporations consent to the adoption (or amendment) of an apportionment plan by checking the box to that effect on such form. For purposes of this paragraph (c)—

(i) An apportionment plan that is adopted (including a plan that has been amended) continues in effect until it is terminated;

(ii) A consolidated group is treated as one component member of such group; and

(iii) The members must allocate the amounts of the section 1561(a) items between or among themselves as described in the plan.

(2) Limitation on adopting a plan— (i) Sufficient statute of limitations period. The members may only adopt or amend such a plan if there is at least one year remaining in the statutory period (including any extensions thereof) for the assessment of a deficiency against every member the tax liability of which would be increased by the adoption of such a plan.

(ii) Insufficient statute of limitations period. If any member cannot satisfy the requirement of paragraph (c)(2)(i) of this section, the members may not adopt or amend such a plan unless the member not satisfying such requirement has entered into an agreement with the Internal Revenue Service to extend the statute of limitations for the limited purpose of assessing any deficiency against such member attributable to the adoption of such a plan.

(3) Termination of plan. An apportionment plan that is in effect for the component members of a controlled group with respect to a particular December 31 is terminated with respect to a succeeding December 31 if—

(i) Each member of such group consents to the termination of such a plan for such succeeding December 31 by checking the box to that effect on its form;

(ii) The controlled group ceases to remain in existence (within the meaning of section 1563(a)) during the calendar year ending on such succeeding December 31;

(iii) Any corporation which was a component member of such group on the particular December 31 is not a component member of such group on such succeeding December 31; or

(iv) Any corporation which was not a component member of such group on the particular December 31 is a component member of such group on such succeeding December 31.

(d) Effective date— (1) Applicability date. This section applies to any taxable year beginning on or after December 22, 2006. However, taxpayers may apply this section to any Federal income tax return filed on or after December 22, 2006.

(2) Expiration date. The applicability of this section will expire on December 21, 2009.

(a) Controlled group of corporations— (1) In general. For purposes of sections 1561 through 1563, the term controlled group of corporations means any group of corporations which is either a parent-subsidiary controlled group (as defined in paragraph (a)(2) of this section), a brother-sister controlled group (as defined in paragraph (a)(3)(i) of this section), a combined group (as defined in paragraph (a)(4) of this section), or a life insurance controlled group (as defined in paragraph (a)(5) of this section). For the exclusion of certain stock for purposes of applying the definitions contained in this paragraph, see section 1563(c) and §1.1563-2.

(2) Parent-subsidiary controlled group. (i) The term parent-subsidiary controlled group means one or more chains of corporations connected through stock ownership with a common parent corporation if—

(A) Stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of each of the corporations, except the common parent corporation, is owned (directly and with the application of §1.1563-3(b)(1), relating to options) by one or more of the other corporations; and

(B) The common parent corporation owns (directly and with the application of §1.1563-3(b)(1), relating to options) stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of at least one of the other corporations, excluding, in computing such voting power or value, stock owned directly by such other corporations.

(ii) The definition of a parent-subsidiary controlled group of corporations may be illustrated by the following examples:

Example 1. P Corporation owns stock possessing 80 percent of the total combined voting power of all classes of stock entitled to vote of S Corporation. P is the common parent of a parent-subsidiary controlled group consisting of member corporations P and S.

Example 2. Assume the same facts as in Example 1. Assume further that S owns stock possessing 80 percent of the total value of shares of all classes of stock of T Corporation. P is the common parent of a parent-subsidiary controlled group consisting of member corporations P, S, and T. The result would be the same if P, rather than S, owned the T stock.

Example 3. L Corporation owns 80 percent of the only class of stock of M Corporation and M, in turn, owns 40 percent of the only class of stock of O Corporation. L also owns 80 percent of the only class of stock of N Corporation and N, in turn, owns 40 percent of the only class of stock of O. L is the common parent of a parent-subsidiary controlled group consisting of member corporations L, M, N, and O.

Example 4. X Corporation owns 75 percent of the only class of stock of Y and Z Corporations; Y owns all the remaining stock of Z; and Z owns all the remaining stock of Y. Since intercompany stockholdings are excluded (that is, are not treated as outstanding) for purposes of determining whether X owns stock possessing at least 80 percent of the voting power or value of at least one of the other corporations, X is treated as the owner of stock possessing 100 percent of the voting power and value of Y and of Z for purposes of paragraph (a)(2)(i)(B) of this section. Also, stock possessing 100 percent of the voting power and value of Y and Z is owned by the other corporations in the group within the meaning of paragraph (a)(2)(i)(A) of this section. (X and Y together own stock possessing 100 percent of the voting power and value of Z, and X and Z together own stock possessing 100 percent of the voting power and value of Y.) Therefore, X is the common parent of a parent-subsidiary controlled group of corporations consisting of member corporations X, Y, and Z.

(3) Brother-sister controlled group— (i) In general. The term brother-sister controlled group means two or more corporations if the same five or fewer persons who are individuals, estates, or trusts own (directly and with the application of the rules contained in §1.1563-3(b)) stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock of each corporation, taking into account the stock ownership of each such person only to the extent such stock ownership is identical with respect to each such corporation.

(ii) Additional stock ownership requirement for purposes of certain other provisions of law. For purposes of any provision of law (other than sections 1561 through 1563) that incorporates the section 1563(a) definition of a controlled group, the term brother-sister controlled group means two or more corporations if the same five or fewer persons who are individuals, estates, or trusts own (directly and with the application of the rules contained in §1.1563-3(b)) stock possessing—

(A) At least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of each corporation (the 80 percent requirement);

(B) More than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock of each corporation, taking into account the stock ownership of each such person only to the extent such stock ownership is identical with respect to each such corporation (the more-than-50 percent identical ownership requirement); and

(C) The five or fewer persons whose stock ownership is considered for purposes of the 80 percent requirement must be the same persons whose stock ownership is considered for purposes of the more-than-50 percent identical ownership requirement.

(iii) Examples. The principles of paragraph (a)(3)(ii) of this section may be illustrated by the following examples:

Example 1. (i) The outstanding stock of corporations P, Q, R, S, and T, which have only one class of stock outstanding is owned by the following unrelated individuals:

(ii) Corporations P and Q are members of a brother-sister controlled group of corporations. Although the more-than-50 percent identical ownership requirement is met for all 5 corporations, corporations R, S, and T are not members because at least 80 percent of the stock of each of those corporations is not owned by the same 5 or fewer persons whose stock ownership is considered for purposes of the more-than-50 percent identical ownership requirement.

Example 2. (i) The outstanding stock of corporations U and V, which have only one class of stock outstanding, is owned by the following unrelated individuals:

(ii) Any group of five of the shareholders will own more than 50 percent of the stock in each corporation, in identical holdings. However, U and V are not members of a brother-sister controlled group because at least 80 percent of the stock of each corporation is not owned by the same five or fewer persons.

Example 3. (i) Corporation X and Y each have two classes of stock outstanding, voting common and non-voting common. (None of this stock is excluded from the definition of stock under section 1563(c).) Unrelated individuals A and B own the following percentages of the class of stock entitled to vote (voting) and of the total value of shares of all classes of stock (value) in each of corporations X and Y:

(ii) No other shareholder of X owns (or is considered to own) any stock in Y. X and Y are a brother-sister controlled group of corporations. The group meets the more-than-50 percent identical ownership requirement because A and B own more than 50 percent of the total value of shares of all classes of stock of X and Y in identical holdings. (The group also meets the more-than-50 percent identical ownership requirement because of A’s voting stock ownership.) The group meets the 80 percent requirement because A and B own at least 80 percent of the total combined voting power of all classes of stock entitled to vote.

Example 4. Assume the same facts as in Example 3 except that the value of the stock owned by A and B is not more than 50 percent of the total value of shares of all classes of stock of each corporation in identical holdings. X and Y are not a brother-sister controlled group of corporations. The group meets the more-than-50 percent identical ownership requirement because A owns more than 50 percent of the total combined voting power of the voting stock of each corporation. For purposes of the 80 percent requirement, B’s voting stock in Y cannot be combined with A’s voting stock in Y since B, who does not own any voting stock in X, is not a person whose ownership is considered for purposes of the more-than-50 percent identical ownership requirement. Because no other shareholder owns stock in both X and Y, these other shareholders’ stock ownership is not counted towards meeting either the more-than-50 percent identical ownership requirement or the 80 percent ownership requirement.

(iv) Special rule if prior law applies. Paragraph (a)(3)(ii) of this section, as amended by T.D. 8179, 1988-1 C.B. 122, applies to taxable years ending on or after December 31, 1970. See, however, the transitional rule in paragraph (d) of this section.

(4) Combined group. (i) The term combined group means any group of three or more corporations if—

(A) Each such corporation is a member of either a parent-subsidiary controlled group of corporations or a brother-sister controlled group of corporations; and

(B) At least one of such corporations is the common parent of a parent-subsidiary controlled group and also is a member of a brother-sister controlled group.

(ii) The definition of a combined group of corporations may be illustrated by the following examples:

Example 1. Smith, an individual, owns stock possessing 80 percent of the total combined voting power of all classes of the stock of corporations X and Y. Y, in turn, owns stock possessing 80 percent of the total combined voting power of all classes of the stock of corporation Z. X, Y, and Z are members of the same combined group since—

(i) X, Y, and Z are each members of either a parent-subsidiary or brother-sister controlled group of corporations; and

(ii) Y is the common parent of a parent-subsidiary controlled group of corporations consisting of Y and Z, and also is a member of a brother-sister controlled group of corporations consisting of X and Y.

Example 2. Assume the same facts as in Example 1, and further assume that corporation X owns 80 percent of the total value of shares of all classes of stock of corporation T. X, Y, Z, and T are members of the same combined group.

(5) Life insurance controlled group. (i) The term life insurance controlled group means two or more life insurance companies each of which is a member of a controlled group of corporations described in paragraph (a)(2), (a)(3)(i), or (a)(4) of this section and to which §1.1502-47(f)(6) does not apply. Such insurance companies shall be treated as a controlled group of corporations separate from any other corporations which are members of a controlled group described in such paragraph (a)(2), (a)(3)(i), or (a)(4). For purposes of this section, the common parent of the controlled group described in paragraph (a)(2) of this section shall be referred to as the common parent of the life insurance controlled group.

(ii) The following examples illustrate the definition of a life insurance controlled group. In these examples, L indicates a life company, another letter indicates a nonlife company and each corporation uses the calendar year as its taxable year.

Example 1. Since January 1, 1999, corporation P has owned all the stock of corporations L₁ and Y, and L₁ has owned all the stock of corporation X. On January 1, 2005, Y acquired all of the stock of corporation L₂. Since L₁ and L₂ are members of a parent-subsidiary controlled group of corporations, such companies are treated as members of a life insurance controlled group separate from the parent-subsidiary controlled group consisting of P, X and Y. For purposes of this section, P is referred to as the common parent of the life insurance controlled group even though P is not a member of such group.

Example 2. The facts are the same as in Example 1, except that, beginning with the 2005 tax year, the P affiliated group elected to file a consolidated return and P made a section 1504(c)(2) election. Pursuant to paragraph (a)(5)(i) of this section, L₁ and L₂ are not members of a separate life insurance controlled group. Instead, P, X, Y, L₁ and L₂ constitute one controlled group. See §1.1502-47(f)(6).

(6) Voting power of stock. For purposes of this section, and §§1.1563-2 and 1.1563-3, in determining whether the stock owned by a person (or persons) possesses a certain percentage of the total combined voting power of all classes of stock entitled to vote of a corporation, consideration will be given to all the facts and circumstances of each case. A share of stock will generally be considered as possessing the voting power accorded to such share by the corporate charter, by-laws, or share certificate. On the other hand, if there is any agreement, whether express or implied, that a shareholder will not vote his stock in a corporation, the formal voting rights possessed by his stock may be disregarded in determining the percentage of the total combined voting power possessed by the stock owned by other shareholders in the corporation, if the result is that the corporation becomes a component member of a controlled group of corporations. Moreover, if a shareholder agrees to vote his stock in a corporation in the manner specified by another shareholder in the corporation, the voting rights possessed by the stock owned by the first shareholder may be considered to be possessed by the stock owned by such other shareholder if the result is that the corporation becomes a component member of a controlled group of corporations.

(b) Component members— (1) In general. For purposes of sections 1561 through 1563, a corporation is a component member of a controlled group of corporations on a December 31 (and with respect to the taxable year which includes such December 31) if such corporation—

(i) Is a member of such controlled group on such December 31 and is not treated as an excluded member under paragraph (b)(2) of this section; or

(ii) Is not a member of such controlled group on such December 31 but is treated as an additional member under paragraph (b)(3) of this section.

(2) Excluded members. (i) A corporation, which is a member of a controlled group of corporations on the December 31 included within its taxable year, but was a member of such group for less than one-half of the number of days in such taxable year which precede such December 31, shall be treated as an excluded member of such group on such December 31.

(ii) A corporation which is a member of a controlled group of corporations on any December 31 shall be treated as an excluded member of such group on such date if, for its taxable year including such date, such corporation is—

(A) Exempt from taxation under section 501(a) (except a corporation which is subject to tax on its unrelated business taxable income under section 511) or 521 for such taxable year;

(B) A foreign corporation not subject to taxation under section 882(a) for the taxable year;

(C) An S corporation (as defined in section 1361) for purposes of any tax benefit item described in section 1561(a) to which it is not subject;

(D) A franchised corporation (as defined in section 1563(f)(4) and §1.1563-4); or

(E) An insurance company subject to taxation under section 801, unless such insurance company (without regard to this paragraph (b)(2)(ii)(E)) is a component member of a life insurance controlled group described in paragraph (a)(5)(i) of this section or unless §1.1502-47(f)(6) applies (which treats a life insurance company, for which a section 1504(c)(2) election is effective, as a member (whether eligible or ineligible) of a life-nonlife affiliated group).

(3) Additional members. A corporation shall be treated as an additional member of a controlled group of corporations on the December 31 included within its taxable year if it—

(i) Is not a member of such group on such December 31;

(ii) Is not described, with respect to such taxable year, in paragraph (b)(2)(ii)(A), (B), (C), (D), or (E) of this section; and

(iii) Was a member of such group for one-half (or more) of the number of days in such taxable year which precede such December 31.

(4) Examples. The provisions of this paragraph may be illustrated by the following examples:

Example 1. Brown, an individual, owns all of the stock of corporations W and X on each day of 1964. W and X each uses the calendar year as its taxable year. On January 1, 1964, Brown also owns all the stock of corporation Y (a fiscal year corporation with a taxable year beginning on July 1, 1964, and ending on June 30, 1965), which stock he sells on October 15, 1964. On December 1, 1964, Brown purchases all the stock of corporation Z (a fiscal year corporation with a taxable year beginning on September 1, 1964, and ending on August 31, 1965). On December 31, 1964, W, X, and Z are members of the same controlled group. However, the component members of the group on such December 31 are W, X, and Y. Under paragraph (b)(2)(i) of this section, Z is treated as an excluded member of the group on December 31, 1964, since Z was a member of the group for less than one-half of the number of days (29 out of 121 days) during the period beginning on September 1, 1964 (the first day of its taxable year) and ending on December 30, 1964. Under paragraph (b)(3) of this section, Y is treated as an additional member of the group on December 31, 1964, since Y was a member of the group for at least one-half of the number of days (107 out of 183 days) during the period beginning on July 1, 1964 (the first day of its taxable year) and ending on December 30, 1964.

Example 2. On January 1, 1964, corporation P owns all the stock of corporation S, which in turn owns all the stock of corporation S-1. On November 1, 1964, P purchases all of the stock of corporation X from the public and sells all of the stock of S to the public. Corporation X owns all the stock of corporation Y during 1964. P, S, S-1, X, and Y file their returns on the basis of the calendar year. On December 31, 1964, P, X, and Y are members of a parent-subsidiary controlled group of corporations; also, corporations S and S-1 are members of a different parent-subsidiary controlled group on such date. However, since X and Y have been members of the parent-subsidiary controlled group of which P is the common parent for less than one-half the number of days during the period January 1 through December 30, 1964, they are not component members of such group on such date. On the other hand, X and Y have been members of a parent-subsidiary controlled group of which X is the common parent for at least one-half the number of days during the period January 1 through December 30, 1964, and therefore they are component members of such group on December 31, 1964. Also since S and S-1 were members of the parent-subsidiary controlled group of which P is the common parent for at least one-half the number of days in the taxable years of each such corporation during the period January 1 through December 30, 1964, P, S, and S-1 are component members of such group on December 31, 1964.

Example 3. Throughout 1964, corporation M owns all the stock of corporation F which, in turn, owns all the stock of corporations L-1, L-2, X, and Y. M is a domestic mutual insurance company subject to taxation under section 821, F is a foreign corporation not engaged in a trade or business within the United States, L-1 and L-2 are domestic life insurance companies subject to taxation under section 802, and X and Y are domestic corporations subject to tax under section 11 of the Code. Each corporation uses the calendar year as its taxable year. On December 31, 1964, M, F, L-1, L-2, X, and Y are members of a parent-subsidiary controlled group of corporations. However, under paragraph (b)(2)(ii) of this section, M, F, L-1, and L-2 are treated as excluded members of the group on December 31, 1964. Thus, on December 31, 1964, the component members of the parent-subsidiary controlled group of which M is the common parent include only X and Y. Furthermore, since paragraph (b)(2)(ii)(E) of this section does not result in L-1 and L-2 being treated as excluded members of a life insurance controlled group, L-1 and L-2 are component members of a life insurance controlled group on December 31, 1964.

(5) Application of constructive ownership rules. For purposes of paragraphs (b)(2)(i) and (3) of this section, it is necessary to determine whether a corporation was a member of a controlled group of corporations for one-half (or more) of the number of days in its taxable year which precede the December 31 falling within such taxable year. Therefore, the constructive ownership rules contained in §1.1563-3(b) (to the extent applicable in making such determination) must be applied on a day-by-day basis. For example, if P Corporation owns all the stock of X Corporation on each day of 1964, and on December 30, 1964, acquires an option to purchase all the stock of Y Corporation (a calendar-year taxpayer which has been in existence on each day of 1964), the application of §1.1563-3(b)(1) on a day-by-day basis results in Y being a member of the brother-sister controlled group on only one day of Y’s 1964 year which precedes December 31, 1964. Accordingly, since Y is not a member of such group for one-half or more of the number of days in its 1964 year preceding December 31, 1964, Y is treated as an excluded member of such group on December 31, 1964.

(c) Overlapping groups— (1) In general. If on a December 31 a corporation is a component member of a controlled group of corporations by reason of ownership of stock possessing at least 80 percent of the total value of shares of all classes of stock of the corporation, and if on such December 31 such corporation is also a component member of another controlled group of corporations by reason of ownership of other stock (that is, stock not used to satisfy the at-least-80 percent total value test) possessing at least 80 percent of the total combined voting power of all classes of stock of the corporation entitled to vote, then such corporation shall be treated as a component member only of the controlled group of which it is a component member by reason of the ownership of at least 80 percent of the total value of its shares.

(2) Brother-sister controlled groups.

* * * * *

(iv) The provisions of this paragraph (c)(2) may be illustrated by the following examples (in which it is assumed that all the individuals are unrelated):

Example 1. (i) On each day of 1970 all the outstanding stock of corporations M, N, and P is held in the following manner:

(ii) Since the more-than-50 percent identical ownership requirement of section 1563(a)(2) is met with respect to corporations M and N and with respect to corporations N and P, but not with respect to corporations M, N, and P, corporation N would, without the application of this paragraph (c)(2), be a component member on December 31, 1970, of overlapping groups consisting of M and N and of N and P. If N does not file an election in accordance with paragraph (c)(2)(i) of this section, the Internal Revenue Service will determine the group in which N is to be included.

Example 2. (i) On each day of 1970, all the outstanding stock of corporations S, T, W, X, and Z is held in the following manner:

(ii) On December 31, 1970, the more-than-50 percent identical ownership requirement of section 1563(a)(2) may be met with regard to any combination of the corporations but all five corporations cannot be included as component members of a single controlled group because the inclusion of all the corporations in a single group would be dependent upon taking into account the stock ownership of more than five persons. Therefore, if the corporations do not file a statement in accordance with paragraph (c)(2)(ii) of this section, the Internal Revenue Service will determine the group in which each corporation is to be included. The corporations or the Internal Revenue Service, as the case may be, may designate that three corporations be included in one group and two corporations in another, or that any four corporations be included in one group and that the remaining corporation not be included in any group.

(d) Transitional rules— (1) In general. Treasury decision 8179 amended paragraph (a)(3)(ii) of this section to revise the definition of a brother-sister controlled group of corporations. In general, those amendments are effective for taxable years ending on or after December 31, 1970.

(2) Limited nonretroactivity. (i) Under the authority of section 7805(b), the Internal Revenue Service will treat an old group as a brother-sister controlled group corporations for purposes of applying sections 401, 404(a), 408(k), 409A, 410, 411, 412, 414, 415, and 4971 of the Code and sections 202, 203, 204, and 302 of the Employment Retirement Income Security Act of 1974 (ERISA) in a plan year or taxable year beginning before March 2, 1988, to the extent necessary to prevent an adverse effect on any old member (or any other corporation), or on any plan or other entity described in such sections (including plans, etc., of corporations not part of such old group), that would result solely from the retroactive effect of the amendment to this section by T.D. 8179. An adverse effect includes the disqualification of a plan or the disallowance of a deduction or credit for a contribution to a plan. The Internal Revenue Service, however, will not treat an old member as a member of an old group to the extent that such treatment will have an adverse effect on that old member.

(ii) Section 7805(b) will not be applied pursuant to paragraph (d)(2)(i) of this section to treat an old member of an old group as a member of a brother-sister controlled group to prevent an adverse effect for a taxable year if, for that taxable year, that old member treats or has treated itself as not being a member of that old group for purposes of sections 401, 404(a), 408(k), 409A, 410, 411, 412, 414, 415, and 4971 of the Code and sections 202, 203, 204, and 302 and Title IV of ERISA for such taxable year (such as by filing, with respect to such taxable year, a return, amended return, or claim for credit or refund in which the amount of any deduction, credit, limitation, or tax due is determined by treating itself as not being a member of the old group for purposes of those sections). However, the fact that one or more (but not all) of the old members do not qualify for section 7805(b) treatment because of the preceding sentence will not preclude that old member (or members) from being treated as a member of the old group under paragraph (d)(2)(i) of this section in order to prevent the disallowance of a deduction or credit of another old member (or other corporation) or to prevent the disqualification of, or other adverse effect on, another old member’s plan (or other entity) described in the sections of the Code and ERISA enumerated in such paragraph.

(3) Election of general nonretroactivity. In the case of a taxable year ending on or after December 31, 1970, and before March 2, 1988, an old group will be treated as a brother-sister controlled group of corporations for all purposes of the Code for such taxable year if—

(i) Each old member files a statement consenting to such treatment for such taxable year with the District Director having audit jurisdiction over its return within six months after March 2, 1988; and

(ii) No old member—

(A) Files or has filed, with respect to such taxable year, a return, amended return, or claim for credit or refund in which the amount of any deduction, credit, limitation, or tax due is determined by treating any old member as not a member of the old group; or

(B) Treats the employees of all members of the old group as not being employed by a single employer for purposes of sections 401, 404(a), 408(k), 409A, 410, 411, 412, 414, 415, and 4971 of the Code and sections 202, 203, 204, and 302 of ERISA for such taxable year.

(4) Definitions. For purposes of this paragraph (d)—

(i) An old group is a brother-sister controlled group of corporations, determined by applying paragraph (a)(3)(ii) of this section as in effect before the amendments made by Treasury decision 8179, that is not a brother-sister controlled group of corporations, determined by applying paragraph (a)(3)(ii) of this section as amended by such Treasury decision; and

(ii) An old member is any corporation that is a member of an old group.

(5) Election to choose between membership in more than one controlled group. If—

(i) An old member has filed an election under paragraph (c)(2) of this section to be treated as a component member of an old group for a December 31 before March 2, 1988; and

(ii) That corporation would (without regard to such paragraph) be a component member of more than one brother-sister controlled group (not including an old group) on the December 31, that corporation may make an election under that paragraph by filing an amended return on or before September 2, 1988. This paragraph (d)(5) does not apply to a corporation that is treated as a member of an old group under paragraph (d)(3) of this section.

(6) Refunds. See section 6511(a) for period of limitation on filing claims for credit or refund.

(e) Effective date— (1) Applicability date. Paragraphs (a), (b), (c)(1), (c)(2)(iv) and (d) of this section apply to taxable years beginning on or after December 22, 2006. However, taxpayers may apply these paragraphs to any Federal income tax return filed on or after December 22, 2006. Paragraphs (c)(2)(i) through (iii) of this section apply to any original Federal income tax return (including any amended return filed on or before the due date (including extensions) of such original return) timely filed on or after May 30, 2006.

(2) Expiration date. The applicability of paragraphs (a), (b), (c)(1), (c)(2)(iv) and (d) of this section will expire on December 21, 2009. The applicability of paragraphs (c)(2)(i) through (iii) of this section will expire on May 26, 2009.

Under the 2001 interim rules and these regulations, a plan or issuer is not required to provide coverage for any particular benefit to any group of similarly situated individuals. However, benefits provided must be uniformly available to all similarly situated individuals. Likewise, any restriction on a benefit or benefits must apply uniformly to all similarly situated individuals and must not be directed at individual participants or beneficiaries based on any health factor of the participants or beneficiaries (determined based on all the relevant facts and circumstances).

With respect to these benefit rules, the Departments received many inquiries about HRAs and one comment about nondiscrimination requirements under other laws. Under HRAs, employees are reimbursed for medical expenses up to a maximum amount for a period, based on the employer’s contribution to the plan. These plans may or may not be funded. Another common feature is that the plans typically allow amounts remaining available at the end of the period to be used to reimburse medical expenses in later periods. Because the maximum reimbursement available under a plan to an employee in any single period may vary based on the claims experience of the employee, concerns have arisen about the application of the HIPAA nondiscrimination rules to these plans.

To address these concerns, these final regulations include an example under which the carryforward of unused employer-provided medical care reimbursement amounts to later years does not violate the HIPAA nondiscrimination requirements, even though the maximum reimbursement amount for a year varies among employees within the same group of similarly situated individuals based on prior claims experience. In the example, an employer sponsors a group health plan under which medical care expenses are reimbursed up to an annual maximum amount. The maximum reimbursement amount with respect to an employee for a year is a uniform amount multiplied by the number of years the employee has participated in the plan, reduced by the total reimbursements for prior years. Because employees who have participated in the plan for the same length of time are eligible for the same total benefit over that length of time, the example concludes that the arrangement does not violate the HIPAA nondiscrimination requirements.

The Equal Employment Opportunity Commission (EEOC) asked the Departments to clarify that certain plan practices or provisions permitted under the benefits paragraphs of the 2001 interim rules may violate the Americans with Disabilities Act of 1990 (ADA) or Title VII of the Civil Rights Act of 1964 (Title VII). Specifically, the 2001 interim rules allow plans to exclude or limit benefits for certain types of conditions or treatments. The EEOC commented that, if such a benefit limit were applied to AIDS, it would be a disability-based distinction that violates the ADA (unless it is permitted under section 501(c) of the ADA). In addition, the EEOC commented that an exclusion from coverage of prescription contraceptives, but not of other preventive treatments, would violate Title VII because prescription contraceptives are used exclusively by women.

Paragraph (h) of the 2001 interim rules and these final regulations is entitled “No effect on other laws.” This section clarifies that compliance with the nondiscrimination rules is not determinative of compliance with any other provision of ERISA, or any other State or Federal law, including the ADA. Moreover, in paragraph (b) of the 2001 interim rules and these final regulations, the general rule governing the application of the nondiscrimination rules to benefits clarifies that whether any plan provision or practice with respect to benefits complies with these rules does not affect whether the provision or practice is permitted under any other provision of the Code, ERISA, or the PHS Act, the Americans with Disabilities Act, or any other law, whether State or Federal.

Many other laws may regulate plans and issuers in their provision of benefits to participants and beneficiaries. These laws include the ADA, Title VII, the Family and Medical Leave Act, ERISA’s fiduciary provisions, and State law. The Departments have not attempted to summarize the requirements of those laws in the HIPAA nondiscrimination rules. Instead, these rules clarify the application of the HIPAA nondiscrimination rules to group health plans, which may permit certain practices that other laws prohibit. Nonetheless, to avoid misleading plans and issuers as to the permissibility of any plan provision under other laws, the Departments included, in both paragraph (h) and paragraph (b) of the regulations, references to the potential applicability of other laws. Employers, plans, issuers, and other service providers should consider the applicability of these laws to their coverage and contact legal counsel or other government agencies such as the EEOC and State insurance departments if they have questions under those laws.

Some plans and issuers, while generally providing coverage for the treatment of an injury, deny benefits if the injury arose from a specified cause or activity. These kinds of exclusions are known as source-of-injury exclusions. Under the 2001 interim rules, if a plan or issuer provides benefits for a particular injury, it may not deny benefits otherwise provided for treatment of the injury due to the fact that the injury results from a medical condition or an act of domestic violence. Two examples in the 2001 interim rules illustrate the application of this rule, to injuries resulting from an attempted suicide due to depression and to injuries resulting from bungee jumping.

These final regulations retain the provisions in the 2001 interim rules and add a clarification. Some people have inquired if a suicide exclusion can apply if an individual had not been diagnosed with a medical condition such as depression before the suicide attempt. These final regulations clarify that benefits may not be denied for injuries resulting from a medical condition even if the medical condition was not diagnosed before the injury.

Some comments expressed concern that the discussion of the source-of-injury rule in the 2001 interim rules might be used to support the use of vague language to identify plan benefit exclusions, especially to identify source-of-injury exclusions. Requirements for plan benefit descriptions are generally outside of the scope of these regulations. Nonetheless, Department of Labor regulations at 29 CFR 2520.102-2(b) provide, “The format of the summary plan description must not have the effect of misleading, misinforming or failing to inform participants and beneficiaries. Any description of exception, limitations, reductions, and other restrictions of plan benefits shall not be minimized, rendered obscure or otherwise made to appear unimportant … The advantages and disadvantages of the plan shall be presented without either exaggerating the benefits or minimizing the limitations.” State laws governing group insurance or nonfederal governmental plans may provide additional protections.

The Departments received thousands of comments protesting that the source-of-injury provisions in the 2001 interim rules would generally permit plans or issuers to exclude benefits for the treatment of injuries sustained in the activities listed in the conference report to HIPAA (motorcycling, snowmobiling, all-terrain vehicle riding, horseback riding, skiing, and other similar activities). Many comments requested that the source-of-injury rule be amended to provide that a source-of-injury exclusion could not apply if the injury resulted from (in addition to an act of domestic violence or a medical condition) participation in legal recreational activities such as those listed in the conference report. Some comments expressed the concern that the rule in the 2001 interim rules would cause plans and issuers to begin excluding benefits for treatment of injuries sustained in these kinds of activities.

One comment generally supported the position in the 2001 interim rules. That comment expressed the belief that Congress intended with this issue, as with many other issues, to continue its longstanding deference to the States on the regulation of benefit design under health insurance. The comment also noted that the source-of-injury rule in the 2001 interim rules would not change the practice of plans or issuers with regard to the activities listed in the conference report and that the practice of plans and issuers in this regard would continue to be governed, as they had been before HIPAA, by market conditions and the States.

The Departments have not added the list of activities from the conference report to the source-of-injury rule in the final regulations. The statute itself is unclear about how benefits in general are affected by the nondiscrimination requirements and is silent with respect to source-of-injury exclusions in particular. The legislative history provides that the inclusion of evidence of insurability in the list of health factors is intended to ensure, among other things, that individuals are not excluded from health care coverage due to their participation in the activities listed in the conference report. This language is unclear because the term “health care coverage” could mean only eligibility to enroll for coverage under the plan, so that people who participate in the activities listed in the conference report could not be kept out of the plan but could be denied benefits for injuries sustained in those activities. Alternatively, it could mean eligibility both to enroll for coverage and for benefits, so that people who participate in those activities could not be kept out of the plan or denied benefits for injuries sustained in those activities. Without any indication in the statute and without a clear indication in the legislative history about this issue, and in light of the overall scheme of the statute, the Departments have made no changes to the regulations.

Moreover, to the extent not prohibited by State law, plans and issuers have been free to impose source-of-injury exclusions since before HIPAA. There is no reason to believe that plans and issuers will begin to impose source-of-injury exclusions with respect to the conference report activities merely because such exclusions are not prohibited under the 2001 interim rules and these final regulations.

Questions have arisen about the relationship of the prohibition on nonconfinement clauses in the 2001 interim rules to State extension-of-benefits laws. Plan provisions that deny an individual benefits based on the individual’s confinement to a hospital or other health care institution at the time coverage would otherwise become effective are often called nonconfinement clauses. The 2001 interim rules prohibit such nonconfinement clauses. At the same time, many States require issuers to provide benefits beyond the date on which coverage under the policy would otherwise have ended to individuals who continue to be hospitalized beyond that date. Example 2 in the 2001 interim rules illustrated that a current issuer cannot impose a nonconfinement clause that restricts benefits for an individual based on whether that individual is entitled to continued benefits from a prior issuer pursuant to a State law requirement. The final sentence in Example 2 provided that HIPAA does not affect the prior issuer’s obligation under State law and does not affect any State law governing coordination of benefits.

Under the laws of some States, a prior issuer has the obligation to provide health benefits to an individual confined to a hospital beyond the nominal end of the policy only if the hospitalization is not covered by a succeeding issuer. Because HIPAA requires a succeeding issuer to provide benefits that it would otherwise provide if not for the nonconfinement clause, in such a case State law would not require the prior issuer to provide benefits for a confinement beyond the nominal end of the policy. In this context, the statement in the final sentence of Example 2 — that HIPAA does not affect the prior issuer’s obligation under State law — could be read to conflict with the text of the rule and the main point of Example 2 that the succeeding issuer must cover the confinement.

There has been some dispute about how this potential ambiguity should be resolved. One interpretation is that the succeeding issuer can never impose a nonconfinement clause, and if this has the effect under State law of not requiring the prior issuer to provide benefits beyond the nominal end of the policy, then the prior issuer is not obligated to provide the extended benefits. This interpretation is consistent with the text of the nonconfinement rule and the main point of Example 2, though it could be read to conflict with the last sentence in Example 2.

Another interpretation proposed by some is that, consistent with the last sentence of Example 2, the obligation of a prior issuer is never affected by the HIPAA prohibition against nonconfinement clauses. Under this interpretation, if a State law conditions a prior issuer’s obligation on there being no succeeding issuer with the obligation, then in order to leave the prior issuer’s obligation unaffected under State law, the succeeding issuer could apply a nonconfinement clause and the HIPAA prohibition would not apply. This interpretation elevates a minor clarification at the end of an example to supersede not only the main point of the example but also the express text of the rule the example illustrates. This proposed interpretation is clearly contrary to the intent of the 2001 interim rules.

To avoid other interpretations, these final rules have replaced the final sentence of Example 2 in the 2001 interim rules with three sentences. The new language clarifies that: State law cannot change the succeeding issuer’s obligation under HIPAA; a prior issuer may also have an obligation; and in a case in which a succeeding issuer has an obligation under HIPAA and a prior issuer has an obligation under State law to provide benefits for a confinement, any State laws designed to prevent more than 100 percent reimbursement, such as State coordination-of-benefits laws, continue to apply. Thus, under HIPAA a succeeding issuer cannot deny benefits to an individual on the basis of a nonconfinement clause. If this requirement under HIPAA has the effect under State law of removing a prior issuer’s obligation to provide benefits, then the prior issuer is not obligated to provide benefits for the confinement. If under State law this requirement under HIPAA has the effect of obligating both the prior issuer and the succeeding issuer to provide benefits, then any State coordination-of-benefits law that is used to determine the order of payment and to prevent more than 100 percent reimbursement continues to apply.

The final regulations make no changes to the 2001 interim rules relating to actively-at-work provisions. Actively-at-work clauses are generally prohibited, unless individuals who are absent from work due to any health factor are treated, for purposes of health coverage, as if they are actively at work. Nonetheless, a plan or issuer may distinguish between groups of similarly situated individuals (provided the distinction is not directed at individual participants or beneficiaries based on a health factor). Examples in the regulations illustrate that a plan or issuer may condition coverage on an individual’s meeting the plan’s requirement of working full-time (such as a minimum of 250 hours in a three-month period or 30 hours per week).

Several members of the regulated community have asked the Departments to clarify the applicability of the actively-at-work rules to various plan provisions that require an individual to perform a minimum amount of service per week in order to be eligible for coverage. It is the Departments’ experience that much of the complexity in applying these rules derives from the myriad variations in the operation of employers’ leave policies. The Departments believe that the 2001 interim rules provide adequate principles for applying the actively-at-work provisions to different types of eligibility provisions. In order to comply with these rules, a plan or issuer should apply the plan’s service requirements consistently to all similarly situated employees eligible for coverage under the plan without regard to whether an employee is seeking eligibility to enroll in the plan or continued eligibility to remain in the plan. Accordingly, if a plan imposes a 30-hour-per-week requirement and treats employees on paid leave (including sick leave and vacation leave) who are already in the plan as if they are actively-at-work, the plan generally is required to credit time on paid leave towards satisfying the 30-hour-per-week requirement for employees seeking enrollment in the plan. Similarly, if a plan allowed employees to continue eligibility under the plan while on paid leave and for an additional period of 30 days while on unpaid leave, the plan is generally required to credit these same periods for employees seeking enrollment in the plan.^[2] To help ensure consistency in application, plans and issuers may wish to clarify, in writing, how employees on various types of leave are treated for purposes of interpreting a service requirement. Without clear plan rules, plans and issuers might slip into inconsistent applications of their rules, which could lead to violations of the actively-at-work provisions.

The HIPAA nondiscrimination provisions do not prevent a plan or issuer from establishing discounts or rebates or modifying otherwise applicable copayments or deductibles in return for adherence to programs of health promotion and disease prevention. The 1997 interim rules refer to these programs as “bona fide wellness programs.” In the preamble to the 1997 interim rules, the Departments invited comments on whether additional guidance was needed concerning, among other things, the permissible standards for determining bona fide wellness programs. The Departments also stated their intent to issue further regulations on the nondiscrimination requirements and that in no event would the Departments take any enforcement action against a plan or issuer that had sought to comply in good faith with section 9802 of the Code, section 702 of ERISA, and section 2702 of the PHS Act before the publication of additional guidance. The preambles to the 2001 interim final and proposed rules noted that the period for nonenforcement in cases of good faith compliance with the HIPAA nondiscrimination provisions generally ended on the applicability date of those regulations but continued with respect to wellness programs until the issuance of further guidance. Accordingly, the nonenforcement policy of the Departments ends upon the applicability date of these final regulations for cases in which a plan or issuer fails to comply with the regulations but complies in good faith with an otherwise reasonable interpretation of the statute.

The HIPAA nondiscrimination provisions generally prohibit a plan or issuer from charging similarly situated individuals different premiums or contributions based on a health factor. These final regulations also generally prohibit a plan or issuer from requiring similarly situated individuals to satisfy differing deductible, copayment, or other cost-sharing requirements. However, the HIPAA nondiscrimination provisions do not prevent a plan or issuer from establishing premium discounts or rebates or modifying otherwise applicable copayments or deductibles in return for adherence to programs of health promotion and disease prevention. Thus, there is an exception to the general rule prohibiting discrimination based on a health factor if the reward, such as a premium discount or waiver of a cost-sharing requirement, is based on participation in a program of health promotion or disease prevention.

Both the 1997 interim rules and the 2001 proposed regulations refer to programs of health promotion and disease prevention allowed under this exception as “bona fide wellness programs.” These regulations generally adopt the provisions in the 2001 proposed rules. However, as more fully explained below, the final regulations no longer use the term “bona fide” in connection with wellness programs, add a description of wellness programs that do not have to satisfy additional requirements in order to comply with the nondiscrimination requirements, reorganize the four requirements from the proposed rules into five requirements, provide that the reward for a wellness program — coupled with the reward for other wellness programs with respect to the plan that require satisfaction of a standard related to a health factor — must not exceed 20% of the total cost of coverage under the plan, and add examples and make other changes to more accurately describe how the requirements apply.

The term “wellness program”. Comments suggested that the use of the term “bona fide” with respect to wellness programs was confusing because, under the proposed rules, some wellness programs that are not “bona fide” within the narrow meaning of that term in the proposed rules nonetheless satisfy the HIPAA nondiscrimination requirements. To address this concern, these final regulations do not use the term “bona fide wellness program.” Instead the final regulations treat all programs of health promotion or disease prevention as wellness programs and specify which of those wellness programs must satisfy additional standards to comply with the nondiscrimination requirements.

Programs not subject to additional standards. The preamble to the 2001 proposed rules described a number of wellness programs that comply with the HIPAA nondiscrimination requirements without having to satisfy any additional standards. However, the text of the regulation did not make such a distinction. The Departments have received many comments and inquiries about whether programs like those described in the 2001 preamble would have to satisfy the additional standards in the proposed rules. As a result, a paragraph has been added to the final regulations defining and illustrating programs that comply with the nondiscrimination requirements without having to satisfy any additional standards (assuming participation in the program is made available to all similarly situated individuals). Such programs are those under which none of the conditions for obtaining a reward is based on an individual satisfying a standard related to a health factor or under which no reward is offered. The final regulations include the following list to illustrate the wide range of programs that would not have to satisfy any additional standards to comply with the nondiscrimination requirements:

Only programs under which any of the conditions for obtaining a reward is based on an individual satisfying a standard related to a health factor must meet the five additional requirements described in paragraph (f)(2) of these regulations in order to comply with the nondiscrimination requirements.

Limit on the reward. As under the proposed rules, the total reward that may be given to an individual under the plan for all wellness programs is limited. A reward can be in the form of a discount or rebate of a premium or contribution, a waiver of all or part of a cost-sharing mechanism (such as deductibles, copayments, or coinsurance), the absence of a surcharge, or the value of a benefit that would otherwise not be provided under the plan. Under the proposed rule, the reward for the wellness program, coupled with the reward for other wellness programs with respect to the plan that require satisfaction of a standard related to a health factor, must not exceed a specified percentage of the cost of employee-only coverage under the plan. The cost of employee-only coverage is determined based on the total amount of employer and employee contributions for the benefit package under which the employee is receiving coverage.

Comments indicated that in some circumstances dependents are permitted to participate in the wellness program in addition to the employee and that in those circumstances the reward should be higher to reflect dependent participation in the program. These final regulations provide that if, in addition to employees, any class of dependents (such as spouses or spouses and dependent children) may participate in the wellness program, the limit on the reward is based on the cost of the coverage category in which the employee and any dependents are enrolled.

The proposed regulations specified three alternative percentages: 10, 15, and 20. The final regulations provide that the amount of the reward may not exceed 20 percent of the cost of coverage. The proposed regulations solicited comments on the appropriate percentage. The percentage limit is designed to avoid a reward or penalty being so large as to have the effect of denying coverage or creating too heavy a financial penalty on individuals who do not satisfy an initial wellness program standard that is related to a health factor. Comments from one employer and two national insurance industry associations requested that the level of the percentage for rewards should provide plans and issuers maximum flexibility for designing wellness programs. Comments suggested that plans and issuers have a greater opportunity to encourage healthy behaviors through programs of health promotion and disease prevention if they are allowed flexibility in designing such programs. The 20 percent limit on the size of the reward in the final regulations allows plans and issuers to maintain flexibility in their ability to design wellness programs, while avoiding rewards or penalties so large as to deny coverage or create too heavy a financial penalty on individuals who do not satisfy an initial wellness program standard that is related to a health factor.

Reasonably-designed and at-least-once-per-year requirements. In the 2001 proposed rules, the second of four requirements was that the program must be reasonably designed to promote good health or prevent disease. The regulations also provided that a program did not meet this standard unless it gave individuals eligible for the program the opportunity to qualify for the reward at least once per year.

One comment suggested a safe harbor under which a wellness program that allows individuals to qualify at least once a year for the reward under the program would satisfy the “reasonably designed” standard without regard to other attributes of the program. The Departments have not adopted this suggestion. The “reasonably designed” standard is a broad standard. A wide range of factors could affect the reasonableness of the design of a wellness program, not just the frequency with which a participant could qualify for the reward. For example, a program might not be reasonably designed to promote good health or prevent disease if it imposed, as a condition to obtaining the reward, an overly burdensome time commitment or a requirement to engage in illegal behavior. The once-per-year requirement was included in the proposed rules merely as a bright-line standard for determining the minimum frequency that is consistent with a reasonable design for promoting good health or preventing disease. Thus, this second requirement of the proposed rules has been divided into two requirements in the final rules (the second and the third requirements). This division was made to emphasize that a program that must satisfy the additional standards in order to comply with the nondiscrimination requirements must allow eligible individuals to qualify for the reward at least once per year and must also be otherwise reasonably designed to promote health or prevent disease.

Comments also expressed other concerns about the “reasonably designed” requirement. While acknowledging that this standard provides significant flexibility, these comments were concerned that this flexible approach might also require substantial resources in evaluating all the facts and circumstances of a proposed program to determine whether it was reasonable in its design.

The “reasonably designed” requirement is intended to be an easy standard to satisfy. To make this clear, the final regulations have added language providing that if a program has a reasonable chance of improving the health of participants and it is not overly burdensome, is not a subterfuge for discriminating based on a health factor, and is not highly suspect in the method chosen to promote health or prevent disease, it satisfies this standard. There does not need to be a scientific record that the method promotes wellness to satisfy this standard. The standard is intended to allow experimentation in diverse ways of promoting wellness. For example, a plan or issuer could satisfy this standard by providing rewards to individuals who participated in a course of aromatherapy. The requirement of reasonableness in this standard prohibits bizarre, extreme, or illegal requirements in a wellness program.

One comment requested that the final regulations set forth one or more safe harbors that would demonstrate compliance with the “reasonably designed” standard. The examples in the proposed and final regulations present a range of wellness programs that are well within the borders of what is considered reasonably designed to promote health or prevent disease. The examples serve as safe harbors, so that a plan or issuer could adopt a program identical to one described as satisfying the wellness program requirements in the examples and be assured of satisfying the requirements in the regulations. Wellness programs similar to the examples also would satisfy the “reasonably designed” requirement. The Departments, though, do not want plans or issuers to feel constrained by the relatively narrow range of programs described by the examples but want plans and issuers to feel free to consider innovative programs for motivating individuals to make efforts to improve their health.

Reasonable alternative standard. Under the 2001 proposed rules and these final regulations, a wellness program that provides a reward requiring satisfaction of a standard related to a health factor must provide a reasonable alternative standard for obtaining the reward for certain individuals. This alternative standard must be available for individuals for whom, for that period, it is unreasonably difficult due to a medical condition to satisfy the otherwise applicable standard, or for whom, for that period, it is medically inadvisable to attempt to satisfy the otherwise applicable standard. A program does not need to establish the specific reasonable alternative standard before the program commences. It is sufficient to determine a reasonable alternative standard once a participant informs the plan that it is unreasonably difficult for the participant due to a medical condition to satisfy the general standard (or that it is medically inadvisable for the participant to attempt to achieve the general standard) under the program.

Some comments suggested that the requirement to devise and offer such a reasonable alternative standard potentially creates a significant burden on plans and issuers. Comments also suggested that the Departments should define a “safe harbor” for what constitutes a reasonable alternative standard, and that plans and issuers should be permitted to establish a single alternative standard, rather than having to tailor a standard for each individual for whom a reasonable alternative standard must be offered.

The Departments understand that, in devising wellness programs, plans and issuers strive to improve the health of participating individuals in a way that is not administratively burdensome or expensive. Under the proposed and final rules, it is permissible for a plan or issuer to devise a reasonable alternative standard by lowering the threshold of the existing health-factor-related standard, substituting a different standard, or waiving the standard. (For the alternative standard to be reasonable, the individual must be able to satisfy it without regard to any health factor.) To address the concern regarding the potential burden of this requirement, the final regulations explicitly provide that a plan or issuer can waive the health-factor-related standard for all individuals for whom a reasonable alternative standard must be offered. Additionally, the final regulations include an example demonstrating that a reasonable alternative standard could include following the recommendations of an individual’s physician regarding the health factor at issue. Thus, a plan or issuer need not assume the burden of designing a discrete alternative standard for each individual for whom an alternative standard must be offered. An example also illustrates that if an alternative standard is health-factor-related (i.e., walking three days a week for 20 minutes a day), the wellness program must provide an additional alternative standard (i.e., following the individual’s physician’s recommendations regarding the health factor at issue) to the appropriate individuals.

The 2001 proposed rules included an example illustrating a smoking cessation program. Comments expressed concern that, under the proposed regulations, individuals addicted to nicotine who comply with a reasonable alternative standard year after year would always be entitled to the reward even if they did not quit using tobacco. Comments questioned whether this result is consistent with the goal of promoting wellness. The final regulations retain the example from the proposed rules. Comments noted that overcoming an addiction sometimes requires a cycle of failure and renewed effort. For those individuals for whom it remains unreasonably difficult due to an addiction, a reasonable alternative standard must continue to be offered. Plans and issuers can accommodate this health factor by continuing to offer the same or a new reasonable alternative standard. For example, a plan or issuer using a smoking cessation class might use different classes from year to year or might change from using a class to providing nicotine replacement therapy. These final regulations provide an additional example of a reasonable alternative standard of viewing, over a period of 12 months, a 12-hour video series on health problems associated with tobacco use.

Concern has been expressed that individuals might claim that it would be unreasonably difficult or medically inadvisable to meet the wellness program standard, when in fact the individual could meet the standard. The final rules clarify that plans may seek verification, such as a statement from a physician, that a health factor makes it unreasonably difficult or medically inadvisable for an individual to meet a standard.

Disclosure requirements. The fifth requirement for a wellness program that provides a reward requiring satisfaction of a standard related to a health factor is that all plan materials describing the terms of the program must disclose the availability of a reasonable alternative standard. This requirement is unchanged from the proposed rules. The 2001 proposed rules and these final regulations include the same model language that can be used to satisfy this requirement; examples also illustrate substantially similar language that would satisfy the requirement.

The final regulations retain the two clarifications of this requirement. First, plan materials are not required to describe specific reasonable alternative standards. It is sufficient to disclose that some reasonable alternative standard will be made available. Second, any plan materials that describe the general standard would also have to disclose the availability of a reasonable alternative standard. However, if the program is merely mentioned (and does not describe the general standard), disclosure of the availability of a reasonable alternative standard is not required.

The sponsor of a self-funded nonfederal governmental plan may elect under section 2721(b)(2) of the PHS Act and 45 CFR 146.180 to exempt its group health plan from the nondiscrimination requirements of section 2702 of the PHS Act and 45 CFR 146.121. Under the interim final nondiscrimination rules, if the plan sponsor subsequently chooses to bring the plan into compliance with the nondiscrimination requirements, the plan must provide notice to that effect to individuals who were denied enrollment based on one or more health factors, and afford those individuals an opportunity, that continues for at least 30 days, to enroll in the plan. (An individual is considered to have been denied coverage if he or she failed to apply for coverage because, given an exemption election under 45 CFR 146.180, it was reasonable to believe that an application for coverage would have been denied based on a health factor). The notice must specify the effective date of compliance, and inform the individual regarding any enrollment restrictions that may apply under the terms of the plan once the plan comes into compliance. The plan may not treat the individual as a late enrollee or a special enrollee. These final regulations retain this transitional rule, and state that the plan must permit coverage to be effective as of the first day of plan coverage for which an exemption election under 45 CFR 146.180 (with regard to the nondiscrimination requirements) is no longer in effect. (These final regulations delete the reference giving the plan the option of having the coverage start July 1, 2001, because that option implicated the expired transitional rules regarding individuals who were denied coverage based on a health factor prior to the applicability of the 2001 interim rules. As previously stated, those transitional rules have not been republished in these final regulations.) Additionally, the examples illustrating how the special rule for nonfederal governmental plans operates have been revised slightly.

These regulations apply for plan years beginning on or after July 1, 2007. Until the applicability date for this regulation, plans and issuers are required to comply with the corresponding sections of the regulations previously published in the Federal Register (66 FR 1378) and other applicable regulations.

Under the Paperwork Reduction Act of 1995, we are required to provide notice in the Federal Register and solicit public comment before a collection of information requirement is submitted to the Office of Management and Budget (OMB) for review and approval. In order to fairly evaluate whether an information collection should be approved by OMB, section 3506(c)(2)(A) of the Paperwork Reduction Act of 1995 requires that we solicit comment on the following issues:

Department regulations in 45 CFR 146.121(i)(4) require that if coverage has been denied to any individual because the sponsor of a self-funded nonfederal governmental plan has elected under 45 CFR Part 146 to exempt the plan from the requirements of this section, and the plan sponsor subsequently chooses to bring the plan into compliance, the plan must: notify the individual that the plan will be coming into compliance; afford the individual an opportunity to enroll that continues for at least 30 days, specify the effective date of compliance; and inform the individual regarding any enrollment restrictions that may apply once the plan is in compliance.

The burden associated with this requirement was approved by The Office of Management and Budget (OMB) under OMB control number 0938-0827, with a current expiration date of April 30, 2009.

In addition, CMS-2078-P, published in the Federal Register on January 8, 2001 (66 FR 1421) describes the bona fide wellness programs and specifies their criteria. Section 146.121(f)(1)(iv) further stipulates that the plan or issuer disclose in all plan materials describing the terms of the program the availability of a reasonable alternative standard to qualify for the reward under a wellness program. However, in plan materials that merely mention that a program is available, without describing its terms, the disclosure is not required.

The burden associated with this requirement was approved by OMB control number 0938-0819, with a current expiration date of April 30, 2009.

Many of the provisions of these regulations serve to specify more precisely than the statute alone exactly what practices are prohibited by HIPAA as unlawful discrimination in eligibility or employee premiums among similarly situated employees. For example, under the regulations, eligibility generally may not be restricted based on an individual’s participation in risky activities, confinement to an institution, or absence from work on an individual’s enrollment date due to illness. The regulations provide that various plan features including waiting periods and eligibility for certain benefits constitute rules for eligibility which may not vary across similarly situated individuals based on health factors. They also provide that plans may not reclassify employees based on health factors in order to create separate groups of similarly situated individuals among which discrimination would be permitted.

All of these provisions have the effect of clarifying and ensuring certain participants’ right to freedom from discrimination in eligibility and premium amounts, thereby securing their access to affordable group health plan coverage. The costs and benefits attributable to these provisions resemble those attendant to HIPAA’s statutory nondiscrimination provisions. Securing participants’ access to affordable group coverage provides economic benefits by reducing the numbers of uninsured and thereby improving health outcomes. The regulations entail a shifting of costs from the employees whose rights are secured (and/or from other parties who would otherwise pay for their health care) to plan sponsors (or to other plan participants if sponsors pass those costs back to them).

The Departments lack any basis on which to distinguish these benefits and costs from those of the statute itself. It is unclear how many plans were engaging in the discriminatory practices targeted for prohibition by these regulatory provisions. Because these provisions operate largely at the margin of the statutory requirements, it is likely that the effects of these provisions were far smaller than the similar statutory effects. The Departments are confident, however, that by securing employees’ access to affordable coverage at the margin, the regulations, like the statute, have yielded benefits that justify costs.

Additional economic benefits derive directly from the improved clarity provided by the regulations. The regulation provides clarity through both its provisions and its examples of how those provisions apply in various circumstances. By clarifying employees’ rights and plan sponsors’ obligations under HIPAA’s nondiscrimination provisions, the regulations reduce uncertainty and costly disputes over these rights and obligations. Greater clarity promotes employers’ and employees’ common understanding of the value of group health plan benefits and confidence in the security and predictability of those benefits, thereby improving labor market efficiency and fostering the establishment and continuation of group health plans by employers.

As noted earlier in this preamble, the Departments have not modified the 2001 interim rules in any way that would impact the original cost estimates or the magnitude of the statutory transfers. Accordingly, no impact is attributable to these final regulations when measured against the baseline of the interim final rules. The provisions of the 2001 interim rules offer the appropriate baseline for this measurement because these rules were generally applicable for plan years beginning on or after July 1, 2001.

Under the first requirement, any reward, whether applicable to employee premiums or benefit levels, must not exceed 20 percent of the total premium for employee-only coverage under the plan (with additional provisions related to rewards that apply also to classes of dependents). This percentage is the highest of the three alternative percentages suggested in the proposed rule, and the award limit used for purposes of the analysis of the proposed rule, which was 15 percent — the midpoint of the three alternative percentages suggested in the proposal. The estimates here also reflect increases in average annual premiums and the numbers of plans and participants since publication of the proposed rules.

The Departments lack representative data on the magnitude of the rewards applied by affected plans today. One consultant practicing in this area suggested that wellness incentive premium discounts ranged from about 3 percent to 23 percent, with an average of about 11 percent.^[21] This suggests that most affected plans, including some whose discounts are somewhat larger than average, already comply with the first requirement and will not need to reduce the size of the rewards they apply. It appears likely, however, that perhaps a few thousand plans covering approximately one hundred thousand participants will need to reduce the size of their rewards in order to comply with the first requirement.

The Departments considered the potential economic effects of requiring these plans to reduce the size of their rewards. These effects are likely to include a shifting of costs between plan sponsors and participants, as well as new economic costs and benefits. Shifts in costs will arise as plans reduce rewards where necessary. Plan sponsors can exercise substantial control over the size and direction of these shifts. Limiting the size of rewards restricts only the differential treatment between participants who satisfy wellness program standards and those who do not. It does not, for example, restrict plans sponsors’ flexibility to determine the overall respective employer and employee shares of base premiums. Possible outcomes include a shifting of costs to plan sponsors from participants who satisfy wellness program standards, from plan sponsors to participants who do not satisfy the standards, from participants who satisfy the standards to those who do not, or some combination of these.

The Departments developed a very rough estimate of the total amount of costs that might derive from this requirement. The Departments’ estimate assumes that (1) all rewards take the form of employee premium discounts; (2) discounts are distributed evenly within both the low-to-average range and the average-to-high range, and are distributed across these ranges such that their mean equals the assumed average; and (3) 70 percent of participants qualify for the discount. The 4,000 affected plans could satisfy this requirement by reducing the premium discount for the 100,000 participants who successfully complete a certified wellness program. When applied to the 2005 average annual employee-only premium of $4,024,^[22] discounts range from $115 to $920, with an average of $460. The maximum allowable discount based on 20 percent of current premium is $805. Reducing all discounts greater than $805 to that amount will result in an average annual reduction of about $57. Applying this reduction to the 100,000 participants assumed to be covered by 4,000 plans affected by the limit results in an estimate of the aggregate cost at $6 million.

New economic costs and benefits may arise if changes in the size of rewards result in changes in participant behavior. Net economic welfare might be lost if some wellness programs’ effectiveness is eroded, but the magnitude and incidence of such effects is expected to be negligible. Consider a wellness program that discounts premiums for participants who take part in an exercise program. It is plausible that, at the margin, a few participants who would take part in order to obtain an existing discount will not take part to obtain a somewhat lower discount. This effect is expected to be negligible, however. Reductions in discounts are likely to average about $57 annually, which is very small when spread over biweekly pay periods. Moreover, the final regulation limits only rewards applied to similarly situated individuals in the context of a group health plan. It does not restrict plan sponsors from encouraging healthy lifestyles in other ways, such as by varying life insurance premiums.

On the other hand, net economic welfare likely will be gained in instances where large premium differentials would otherwise have served to discourage enrollment in health plans by employees who did not satisfy wellness program requirements.

The Departments believe that the net economic gains from prohibiting rewards so large that they could discourage enrollment based on health factors justify any net losses that might derive from the negligible reduction of some employees’ incentive to participate in wellness programs.

Under the second requirement, the program must be reasonably designed to promote health or prevent disease. The Departments believe that a program that is not so designed would not provide economic benefits, but would serve merely to shift costs from plan sponsors to targeted individuals based on health factors. Comments received by the Departments and available literature on employee wellness programs, however, suggest that existing wellness programs generally satisfy this requirement. As was stated in the analysis of the proposed rule, this requirement therefore is not expected to compel plans to modify existing wellness programs or entail additional economic costs.

Although this requirement was included in the proposal within the requirement for reasonable design, it has been reorganized as a separate provision in these final regulations. At the time of the proposal, the Departments assumed that most plans satisfied the requirements for reasonable design, such that they would not be required to modify existing programs. Accordingly, no cost was attributed to the reasonable design requirements when taken together. The Departments did request comments on this assumption, but received no additional information in response. Accordingly, the Departments have not attributed a cost to this provision of the final regulations.

The fourth requirement provides that where rewards are conditioned on satisfaction of a standard related to a health factor, rewards must be available to all similarly situated individuals. A reward is not available to all similarly situated individuals unless the program allows for a reasonable alternative standard if the otherwise applicable initial standard is unreasonably difficult to achieve due to a medical condition or medically inadvisable for the individual to meet. In particular, the program must offer any such individual the opportunity to satisfy a reasonable alternative standard. Comments received by the Departments and available literature on employee wellness programs suggest that some wellness programs do not currently satisfy this requirement and will have to be modified. The Departments estimate that among employers that provide incentives for employees to participate in wellness programs, nine percent require employees to achieve a low risk behavior to qualify for the incentive, 53 percent require a pledge of compliance, and 55 percent require participation in a program.^[23] Depending on the nature of the wellness program, it might be unreasonably difficult due to a medical condition or medically inadvisable for at least some plan participants to achieve the behavior or to comply with or participate in the program.

The Departments identified three broad types of economic impact that might arise from this requirement. First, affected plans will incur some economic cost to make available reasonable alternative standards. Second, additional economic costs and benefits may arise depending on the nature of alternatives provided, individuals’ use of these alternatives, and any changes in the affected individuals’ behavioral and health outcomes. Third, some costs may be shifted from individuals who would fail to satisfy programs’ initial standards, but who will satisfy reasonable alternative standards once available (and thereby qualify for associated rewards), to plan sponsors (or to other participants in their plans if plan sponsors elect to pass these costs back to all participants).

The Departments note that some plans that offer rewards to similarly situated individuals based on their ability to meet a standard related to a health factor (and are therefore subject to the requirement) may not need to provide alternative standards. The requirement provides that alternative standards need not be specified or provided until a participant for whom it is unreasonably difficult due to a medical condition or medically inadvisable to satisfy the initial standard seeks such an alternative. Some wellness programs’ initial standards may be such that no participant would ever find them unreasonably difficult to satisfy due to a medical condition or medically inadvisable to attempt. The Departments estimate that 3,000 potentially affected plans have initial wellness program standards that might be unreasonably difficult for some participants to satisfy due to a medical condition or medically inadvisable to attempt.^[24] Moreover, because alternatives need not be made available until they are sought by qualified plan participants, it might be possible for some plans to go for years without needing to make available an alternative standard. This could be particularly likely for small plans.^[25]

The Departments estimate that as many as 27 percent of participants in plans with rewards that are based on meeting a standard related to a health factor, or 344,000 individuals, might fail to satisfy wellness programs’ initial standards because they are unreasonably difficult due to a medical condition or medically inadvisable to meet.^[26] Of these, only about 30,000 are in the 3,000 plans assumed to apply standards that might be unreasonably difficult due to a medical condition or medically inadvisable for some plan participants to satisfy. The standards would in fact be unreasonably difficult or medically inadvisable to satisfy for some subset of these individuals — roughly two-thirds, or 19,000 by the Departments’ estimate.^[27] Of these, it is assumed that between 5,000 and 19,000 of those individuals that seek alternative standards are able to satisfy them.^[28]

The cost associated with establishing alternative standards is unknown. However, the regulation does not prescribe a particular type of alternative standard that must be provided. Instead, it permits plan sponsors flexibility to provide any reasonable alternative, or to waive the standard, for individuals for whom the initial standard is unreasonably difficult due to a medical condition or medically inadvisable to meet. The Departments expect that plan sponsors will select alternatives that entail the minimum net costs possible. Plan sponsors may select low-cost alternatives, such as requiring an individual for whom it would be unreasonably difficult to quit smoking (and thereby qualify for a non-smoker discount) to attend a smoking cessation program that is available at little or no cost in the community, or to watch educational videos or review educational literature. Plan sponsors presumably will select higher-cost alternatives only if they thereby derive offsetting benefits, such as a higher smoking cessation success rate.

Although there is considerable uncertainty in these estimates, it seems reasonable to assume that the net cost sponsors will incur in the provision of alternatives, including new economic costs and benefits, will not exceed the cost of providing discounts (or waiving surcharges) for all plan participants who qualify for alternatives, which is estimated at between $2 million and $9 million.^[29] Other economic costs and benefits might arise where alternative standards are made available. For example, some individuals might receive a discount for satisfying alternative standards that turn out to be less beneficial to overall health than the initial standard might have been, resulting in a net loss of economic welfare. In other cases, the satisfaction of an alternative standard might produce the desired health improvement, which would represent a net gain in economic welfare.

Although outcomes are uncertain, the Departments note that plan sponsors have strong motivation to identify and provide alternative standards that have positive net economic effects. They will be disinclined to provide alternatives that worsen behavioral and health outcomes, or that make financial rewards available absent meaningful efforts by participants to improve their health habits and health. Instead they will be inclined to provide alternatives that sustain or reinforce plan participants’ incentive to improve their health habits and health, and/or that help participants make such improvements. It therefore seems likely that gains in economic welfare from this requirement will equal or justify losses. The Departments anticipate that the requirement to provide reasonable alternative standards will reduce instances where wellness programs serve only to shift costs to higher risk individuals and increase instances where programs succeed at helping individuals with higher health risks improve their health habits and health.

The fifth requirement provides that plan materials describing wellness program standards that are related to a health factor must disclose the availability of reasonable alternative standards. Under some wellness programs, an individual must satisfy a standard related to a health factor in order to qualify for the reward.

Plans offering wellness programs under which an individual must satisfy a standard related to a health factor in order to qualify for the reward must disclose in all plan materials describing the terms of the program the availability of a reasonable alternative standard. The regulations provide sample language for this disclosure. An actual description of the alternative standard is not required in such materials. In plan materials that merely mention that a wellness program is available but do not describe its terms, this disclosure of the availability of an alternative standard is not required. The Departments generally account elsewhere for plans’ cost of updating such materials to reflect changes in plan provisions as required under various disclosure requirements and as is part of usual business practice. This particular requirement is expected to represent a negligible fraction of the ongoing cost of updating plans’ materials, and is not separately accounted for here.

(a) Health factors. (1) The term health factor means, in relation to an individual, any of the following health status-related factors:

(i) Health status;

(ii) Medical condition (including both physical and mental illnesses), as defined in §54.9801-2;

(iii) Claims experience;

(iv) Receipt of health care;

(v) Medical history;

(vi) Genetic information, as defined in §54.9801-2 of this chapter;

(vii) Evidence of insurability; or

(viii) Disability.

(2) Evidence of insurability includes —

(i) Conditions arising out of acts of domestic violence; and

(ii) Participation in activities such as motorcycling, snowmobiling, all-terrain vehicle riding, horseback riding, skiing, and other similar activities.

(3) The decision whether health coverage is elected for an individual (including the time chosen to enroll, such as under special enrollment or late enrollment) is not, itself, within the scope of any health factor. (However, under §54.9801-6, a plan must treat special enrollees the same as similarly situated individuals who are enrolled when first eligible.)

(b) Prohibited discrimination in rules for eligibility — (1) In general. (i) A group health plan may not establish any rule for eligibility (including continued eligibility) of any individual to enroll for benefits under the terms of the plan that discriminates based on any health factor that relates to that individual or a dependent of that individual. This rule is subject to the provisions of paragraph (b)(2) of this section (explaining how this rule applies to benefits), paragraph (b)(3) of this section (allowing plans to impose certain preexisting condition exclusions), paragraph (d) of this section (containing rules for establishing groups of similarly situated individuals), paragraph (e) of this section (relating to nonconfinement, actively-at-work, and other service requirements), paragraph (f) of this section (relating to wellness programs), and paragraph (g) of this section (permitting favorable treatment of individuals with adverse health factors).

(ii) For purposes of this section, rules for eligibility include, but are not limited to, rules relating to —

(A) Enrollment;

(B) The effective date of coverage;

(C) Waiting (or affiliation) periods;

(D) Late and special enrollment;

(E) Eligibility for benefit packages (including rules for individuals to change their selection among benefit packages);

(F) Benefits (including rules relating to covered benefits, benefit restrictions, and cost-sharing mechanisms such as coinsurance, copayments, and deductibles), as described in paragraphs (b)(2) and (3) of this section;

(G) Continued eligibility; and

(H) Terminating coverage (including disenrollment) of any individual under the plan.

(iii) The rules of this paragraph (b)(1) are illustrated by the following examples:

Example 1. (i) Facts. An employer sponsors a group health plan that is available to all employees who enroll within the first 30 days of their employment. However, employees who do not enroll within the first 30 days cannot enroll later unless they pass a physical examination.

(ii) Conclusion. In this Example 1, the requirement to pass a physical examination in order to enroll in the plan is a rule for eligibility that discriminates based on one or more health factors and thus violates this paragraph (b)(1).

Example 2. (i) Facts. Under an employer’s group health plan, employees who enroll during the first 30 days of employment (and during special enrollment periods) may choose between two benefit packages: an indemnity option and an HMO option. However, employees who enroll during late enrollment are permitted to enroll only in the HMO option and only if they provide evidence of good health.

(ii) Conclusion. In this Example 2, the requirement to provide evidence of good health in order to be eligible for late enrollment in the HMO option is a rule for eligibility that discriminates based on one or more health factors and thus violates this paragraph (b)(1). However, if the plan did not require evidence of good health but limited late enrollees to the HMO option, the plan’s rules for eligibility would not discriminate based on any health factor, and thus would not violate this paragraph (b)(1), because the time an individual chooses to enroll is not, itself, within the scope of any health factor.

Example 3. (i) Facts. Under an employer’s group health plan, all employees generally may enroll within the first 30 days of employment. However, individuals who participate in certain recreational activities, including motorcycling, are excluded from coverage.

(ii) Conclusion. In this Example 3, excluding from the plan individuals who participate in recreational activities, such as motorcycling, is a rule for eligibility that discriminates based on one more health factors and thus violates this paragraph (b)(1).

Example 4. (i) Facts. A group health plan applies for a group health policy offered by an issuer. As part of the application, the issuer receives health information about individuals to be covered under the plan. Individual A is an employee of the employer maintaining the plan. A and A’s dependents have a history of high health claims. Based on the information about A and A’s dependents, the issuer excludes A and A’s dependents from the group policy it offers to the employer.

(ii) Conclusion. See Example 4 in 29 CFR 2590.702(b)(1) and 45 CFR 146.121(b)(1) for a conclusion that the exclusion by the issuer of A and A’s dependents from coverage is a rule for eligibility that discriminates based on one or more health factors and violates rules under 29 CFR 2590.702(b)(1) and 45 CFR 146.121(b)(1) similar to the rules under this paragraph (b)(1). (If the employer is a small employer under 45 CFR 144.103 (generally, an employer with 50 or fewer employees), the issuer also may violate 45 CFR 146.150, which requires issuers to offer all the policies they sell in the small group market on a guaranteed available basis to all small employers and to accept every eligible individual in every small employer group.) If the plan provides coverage through this policy and does not provide equivalent coverage for A and A’s dependents through other means, the plan violates this paragraph (b)(1).

(2) Application to benefits — (i) General rule. (A) Under this section, a group health plan is not required to provide coverage for any particular benefit to any group of similarly situated individuals.

(B) However, benefits provided under a plan must be uniformly available to all similarly situated individuals (as described in paragraph (d) of this section). Likewise, any restriction on a benefit or benefits must apply uniformly to all similarly situated individuals and must not be directed at individual participants or beneficiaries based on any health factor of the participants or beneficiaries (determined based on all the relevant facts and circumstances). Thus, for example, a plan may limit or exclude benefits in relation to a specific disease or condition, limit or exclude benefits for certain types of treatments or drugs, or limit or exclude benefits based on a determination of whether the benefits are experimental or not medically necessary, but only if the benefit limitation or exclusion applies uniformly to all similarly situated individuals and is not directed at individual participants or beneficiaries based on any health factor of the participants or beneficiaries. In addition, a plan may impose annual, lifetime, or other limits on benefits and may require the satisfaction of a deductible, copayment, coinsurance, or other cost-sharing requirement in order to obtain a benefit if the limit or cost-sharing requirement applies uniformly to all similarly situated individuals and is not directed at individual participants or beneficiaries based on any health factor of the participants or beneficiaries. In the case of a cost-sharing requirement, see also paragraph (b)(2)(ii) of this section, which permits variances in the application of a cost-sharing mechanism made available under a wellness program. (Whether any plan provision or practice with respect to benefits complies with this paragraph (b)(2)(i) does not affect whether the provision or practice is permitted under ERISA, the Americans with Disabilities Act, or any other law, whether State or Federal.)

(C) For purposes of this paragraph (b)(2)(i), a plan amendment applicable to all individuals in one or more groups of similarly situated individuals under the plan and made effective no earlier than the first day of the first plan year after the amendment is adopted is not considered to be directed at any individual participants or beneficiaries.

(D) The rules of this paragraph (b)(2)(i) are illustrated by the following examples:

Example 1. (i) Facts. A group health plan applies a $500,000 lifetime limit on all benefits to each participant or beneficiary covered under the plan. The limit is not directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 1, the limit does not violate this paragraph (b)(2)(i) because $500,000 of benefits are available uniformly to each participant and beneficiary under the plan and because the limit is applied uniformly to all participants and beneficiaries and is not directed at individual participants or beneficiaries.

Example 2. (i) Facts. A group health plan has a $2 million lifetime limit on all benefits (and no other lifetime limits) for participants covered under the plan. Participant B files a claim for the treatment of AIDS. At the next corporate board meeting of the plan sponsor, the claim is discussed. Shortly thereafter, the plan is modified to impose a $10,000 lifetime limit on benefits for the treatment of AIDS, effective before the beginning of the next plan year.

(ii) Conclusion. The facts of this Example 2 strongly suggest that the plan modification is directed at B based on B’s claim. Absent outweighing evidence to the contrary, the plan violates this paragraph (b)(2)(i).

Example 3. (i) A group health plan applies for a group health policy offered by an issuer. Individual C is covered under the plan and has an adverse health condition. As part of the application, the issuer receives health information about the individuals to be covered, including information about C’s adverse health condition. The policy form offered by the issuer generally provides benefits for the adverse health condition that C has, but in this case the issuer offers the plan a policy modified by a rider that excludes benefits for C for that condition. The exclusionary rider is made effective the first day of the next plan year.

(ii) Conclusion. See Example 3 in 29 CFR 2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i) for a conclusion that the issuer violates rules under 29 CFR 2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i) similar to the rules under this paragraph (b)(2)(i) because benefits for C’s condition are available to other individuals in the group of similarly situated individuals that includes C but are not available to C. Thus, the benefits are not uniformly available to all similarly situated individuals. Even though the exclusionary rider is made effective the first day of the next plan year, because the rider does not apply to all similarly situated individuals, the issuer violates the rules under 29 CFR 2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i). If the plan provides coverage through this policy and does not provide equivalent coverage for C through other means, the plan violates this paragraph (b)(2)(i).

Example 4. (i) Facts. A group health plan has a $2,000 lifetime limit for the treatment of temporomandibular joint syndrome (TMJ). The limit is applied uniformly to all similarly situated individuals and is not directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 4, the limit does not violate this paragraph (b)(2)(i) because $2,000 of benefits for the treatment of TMJ are available uniformly to all similarly situated individuals and a plan may limit benefits covered in relation to a specific disease or condition if the limit applies uniformly to all similarly situated individuals and is not directed at individual participants or beneficiaries. (This example does not address whether the plan provision is permissible under the Americans with Disabilities Act or any other applicable law.)

Example 5. (i) Facts. A group health plan applies a $2 million lifetime limit on all benefits. However, the $2 million lifetime limit is reduced to $10,000 for any participant or beneficiary covered under the plan who has a congenital heart defect.

(ii) Conclusion. In this Example 5, the lower lifetime limit for participants and beneficiaries with a congenital heart defect violates this paragraph (b)(2)(i) because benefits under the plan are not uniformly available to all similarly situated individuals and the plan’s lifetime limit on benefits does not apply uniformly to all similarly situated individuals.

Example 6. (i) Facts. A group health plan limits benefits for prescription drugs to those listed on a drug formulary. The limit is applied uniformly to all similarly situated individuals and is not directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 6, the exclusion from coverage of drugs not listed on the drug formulary does not violate this paragraph (b)(2)(i) because benefits for prescription drugs listed on the formulary are uniformly available to all similarly situated individuals and because the exclusion of drugs not listed on the formulary applies uniformly to all similarly situated individuals and is not directed at individual participants or beneficiaries.

Example 7. (i) Facts. Under a group health plan, doctor visits are generally subject to a $250 annual deductible and 20 percent coinsurance requirement. However, prenatal doctor visits are not subject to any deductible or coinsurance requirement. These rules are applied uniformly to all similarly situated individuals and are not directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 7, imposing different deductible and coinsurance requirements for prenatal doctor visits and other visits does not violate this paragraph (b)(2)(i) because a plan may establish different deductibles or coinsurance requirements for different services if the deductible or coinsurance requirement is applied uniformly to all similarly situated individuals and is not directed at individual participants or beneficiaries.

Example 8. (i) Facts. An employer sponsors a group health plan that is available to all current employees. Under the plan, the medical care expenses of each employee (and the employee’s dependents) are reimbursed up to an annual maximum amount. The maximum reimbursement amount with respect to an employee for a year is $1500 multiplied by the number of years the employee has participated in the plan, reduced by the total reimbursements for prior years.

(ii) Conclusion. In this Example 8, the variable annual limit does not violate this paragraph (b)(2)(i). Although the maximum reimbursement amount for a year varies among employees within the same group of similarly situated individuals based on prior claims experience, employees who have participated in the plan for the same length of time are eligible for the same total benefit over that length of time (and the restriction on the maximum reimbursement amount is not directed at any individual participants or beneficiaries based on any health factor).

(ii) Exception for wellness programs. A group health plan may vary benefits, including cost-sharing mechanisms (such as a deductible, copayment, or coinsurance), based on whether an individual has met the standards of a wellness program that satisfies the requirements of paragraph (f) of this section.

(iii) Specific rule relating to source-of-injury exclusions. (A) If a group health plan generally provides benefits for a type of injury, the plan may not deny benefits otherwise provided for treatment of the injury if the injury results from an act of domestic violence or a medical condition (including both physical and mental health conditions). This rule applies in the case of an injury resulting from a medical condition even if the condition is not diagnosed before the injury.

(B) The rules of this paragraph (b)(2)(iii) are illustrated by the following examples:

Example 1. (i) Facts. A group health plan generally provides medical/surgical benefits, including benefits for hospital stays, that are medically necessary. However, the plan excludes benefits for self-inflicted injuries or injuries sustained in connection with attempted suicide. Because of depression, Individual D attempts suicide. As a result, D sustains injuries and is hospitalized for treatment of the injuries. Under the exclusion, the plan denies D benefits for treatment of the injuries.

(ii) Conclusion. In this Example 1, the suicide attempt is the result of a medical condition (depression). Accordingly, the denial of benefits for the treatments of D’s injuries violates the requirements of this paragraph (b)(2)(iii) because the plan provision excludes benefits for treatment of an injury resulting from a medical condition.

Example 2. (i) Facts. A group health plan provides benefits for head injuries generally. The plan also has a general exclusion for any injury sustained while participating in any of a number of recreational activities, including bungee jumping. However, this exclusion does not apply to any injury that results from a medical condition (nor from domestic violence). Participant E sustains a head injury while bungee jumping. The injury did not result from a medical condition (nor from domestic violence). Accordingly, the plan denies benefits for E’s head injury.

(ii) Conclusion. In this Example 2, the plan provision that denies benefits based on the source of an injury does not restrict benefits based on an act of domestic violence or any medical condition. Therefore, the provision is permissible under this paragraph (b)(2)(iii) and does not violate this section. (However, if the plan did not allow E to enroll in the plan (or applied different rules for eligibility to E) because E frequently participates in bungee jumping, the plan would violate paragraph (b)(1) of this section.)

(3) Relationship to §54.9801-3. (i) A preexisting condition exclusion is permitted under this section if it —

(A) Complies with §54.9801-3;

(B) Applies uniformly to all similarly situated individuals (as described in paragraph (d) of this section); and

(C) Is not directed at individual participants or beneficiaries based on any health factor of the participants or beneficiaries. For purposes of this paragraph (b)(3)(i)(C), a plan amendment relating to a preexisting condition exclusion applicable to all individuals in one or more groups of similarly situated individuals under the plan and made effective no earlier than the first day of the first plan year after the amendment is adopted is not considered to be directed at any individual participants or beneficiaries.

(ii) The rules of this paragraph (b)(3) are illustrated by the following examples:

Example 1. (i) Facts. A group health plan imposes a preexisting condition exclusion on all individuals enrolled in the plan. The exclusion applies to conditions for which medical advice, diagnosis, care, or treatment was recommended or received within the six-month period ending on an individual’s enrollment date. In addition, the exclusion generally extends for 12 months after an individual’s enrollment date, but this 12-month period is offset by the number of days of an individual’s creditable coverage in accordance with §54.9801-3. There is nothing to indicate that the exclusion is directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 1, even though the plan’s preexisting condition exclusion discriminates against individuals based on one or more health factors, the preexisting condition exclusion does not violate this section because it applies uniformly to all similarly situated individuals, is not directed at individual participants or beneficiaries, and complies with §54.9801-3 (that is, the requirements relating to the six-month look-back period, the 12-month (or 18-month) maximum exclusion period, and the creditable coverage offset).

Example 2. (i) Facts. A group health plan excludes coverage for conditions with respect to which medical advice, diagnosis, care, or treatment was recommended or received within the six-month period ending on an individual’s enrollment date. Under the plan, the preexisting condition exclusion generally extends for 12 months, offset by creditable coverage. However, if an individual has no claims in the first six months following enrollment, the remainder of the exclusion period is waived.

(ii) Conclusion. In this Example 2, the plan’s preexisting condition exclusions violate this section because they do not meet the requirements of this paragraph (b)(3); specifically, they do not apply uniformly to all similarly situated individuals. The plan provisions do not apply uniformly to all similarly situated individuals because individuals who have medical claims during the first six months following enrollment are not treated the same as similarly situated individuals with no claims during that period. (Under paragraph (d) of this section, the groups cannot be treated as two separate groups of similarly situated individuals because the distinction is based on a health factor.)

(c) Prohibited discrimination in premiums or contributions — (1) In general. (i) A group health plan may not require an individual, as a condition of enrollment or continued enrollment under the plan, to pay a premium or contribution that is greater than the premium or contribution for a similarly situated individual (described in paragraph (d) of this section) enrolled in the plan based on any health factor that relates to the individual or a dependent of the individual.

(ii) Discounts, rebates, payments in kind, and any other premium differential mechanisms are taken into account in determining an individual’s premium or contribution rate. (For rules relating to cost-sharing mechanisms, see paragraph (b)(2) of this section (addressing benefits).)

(2) Rules relating to premium rates — (i) Group rating based on health factors not restricted under this section. Nothing in this section restricts the aggregate amount that an employer may be charged for coverage under a group health plan.

(ii) List billing based on a health factor prohibited. However, a group health plan may not quote or charge an employer (or an individual) a different premium for an individual in a group of similarly situated individuals based on a health factor. (But see paragraph (g) of this section permitting favorable treatment of individuals with adverse health factors.)

(iii) Examples. The rules of this paragraph (c)(2) are illustrated by the following examples:

Example 1. (i) Facts. An employer sponsors a group health plan and purchases coverage from a health insurance issuer. In order to determine the premium rate for the upcoming plan year, the issuer reviews the claims experience of individuals covered under the plan. The issuer finds that Individual F had significantly higher claims experience than similarly situated individuals in the plan. The issuer quotes the plan a higher per-participant rate because of F’s claims experience.

(ii) Conclusion. See Example 1 in 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) for a conclusion that the issuer does not violate the provisions of 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) similar to the provisions of this paragraph (c)(2) because the issuer blends the rate so that the employer is not quoted a higher rate for F than for a similarly situated individual based on F’s claims experience.

Example 2. (i) Facts. Same facts as Example 1, except that the issuer quotes the employer a higher premium rate for F, because of F’s claims experience, than for a similarly situated individual.

(ii) Conclusion. See Example 2 in 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) for a conclusion that the issuer violates provisions of 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) similar to the provisions of this paragraph (c)(2). Moreover, even if the plan purchased the policy based on the quote but did not require a higher participant contribution for F than for a similarly situated individual, see Example 2 in 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) for a conclusion that the issuer would still violate 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) (but in such a case the plan would not violate this paragraph (c)(2)).

(3) Exception for wellness programs. Notwithstanding paragraphs (c)(1) and (2) of this section, a plan may vary the amount of premium or contribution it requires similarly situated individuals to pay based on whether an individual has met the standards of a wellness program that satisfies the requirements of paragraph (f) of this section.

(d) Similarly situated individuals. The requirements of this section apply only within a group of individuals who are treated as similarly situated individuals. A plan may treat participants as a group of similarly situated individuals separate from beneficiaries. In addition, participants may be treated as two or more distinct groups of similarly situated individuals and beneficiaries may be treated as two or more distinct groups of similarly situated individuals in accordance with the rules of this paragraph (d). Moreover, if individuals have a choice of two or more benefit packages, individuals choosing one benefit package may be treated as one or more groups of similarly situated individuals distinct from individuals choosing another benefit package.

(1) Participants. Subject to paragraph (d)(3) of this section, a plan may treat participants as two or more distinct groups of similarly situated individuals if the distinction between or among the groups of participants is based on a bona fide employment-based classification consistent with the employer’s usual business practice. Whether an employment-based classification is bona fide is determined on the basis of all the relevant facts and circumstances. Relevant facts and circumstances include whether the employer uses the classification for purposes independent of qualification for health coverage (for example, determining eligibility for other employee benefits or determining other terms of employment). Subject to paragraph (d)(3) of this section, examples of classifications that, based on all the relevant facts and circumstances, may be bona fide include full-time versus part-time status, different geographic location, membership in a collective bargaining unit, date of hire, length of service, current employee versus former employee status, and different occupations. However, a classification based on any health factor is not a bona fide employment-based classification, unless the requirements of paragraph (g) of this section are satisfied (permitting favorable treatment of individuals with adverse health factors).

(2) Beneficiaries. (i) Subject to paragraph (d)(3) of this section, a plan may treat beneficiaries as two or more distinct groups of similarly situated individuals if the distinction between or among the groups of beneficiaries is based on any of the following factors:

(A) A bona fide employment-based classification of the participant through whom the beneficiary is receiving coverage;

(B) Relationship to the participant (for example, as a spouse or as a dependent child);

(C) Marital status;

(D) With respect to children of a participant, age or student status; or

(E) Any other factor if the factor is not a health factor.

(ii) Paragraph (d)(2)(i) of this section does not prevent more favorable treatment of individuals with adverse health factors in accordance with paragraph (g) of this section.

(3) Discrimination directed at individuals. Notwithstanding paragraphs (d)(1) and (2) of this section, if the creation or modification of an employment or coverage classification is directed at individual participants or beneficiaries based on any health factor of the participants or beneficiaries, the classification is not permitted under this paragraph (d), unless it is permitted under paragraph (g) of this section (permitting favorable treatment of individuals with adverse health factors). Thus, if an employer modified an employment-based classification to single out, based on a health factor, individual participants and beneficiaries and deny them health coverage, the new classification would not be permitted under this section.

(4) Examples. The rules of this paragraph (d) are illustrated by the following examples:

Example 1. (i) Facts. An employer sponsors a group health plan for full-time employees only. Under the plan (consistent with the employer’s usual business practice), employees who normally work at least 30 hours per week are considered to be working full-time. Other employees are considered to be working part-time. There is no evidence to suggest that the classification is directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 1, treating the full-time and part-time employees as two separate groups of similarly situated individuals is permitted under this paragraph (d) because the classification is bona fide and is not directed at individual participants or beneficiaries.

Example 2. (i) Facts. Under a group health plan, coverage is made available to employees, their spouses, and their dependent children. However, coverage is made available to a dependent child only if the dependent child is under age 19 (or under age 25 if the child is continuously enrolled full-time in an institution of higher learning (full-time students)). There is no evidence to suggest that these classifications are directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 2, treating spouses and dependent children differently by imposing an age limitation on dependent children, but not on spouses, is permitted under this paragraph (d). Specifically, the distinction between spouses and dependent children is permitted under paragraph (d)(2) of this section and is not prohibited under paragraph (d)(3) of this section because it is not directed at individual participants or beneficiaries. It is also permissible to treat dependent children who are under age 19 (or full-time students under age 25) as a group of similarly situated individuals separate from those who are age 25 or older (or age 19 or older if they are not full-time students) because the classification is permitted under paragraph (d)(2) of this section and is not directed at individual participants or beneficiaries.

Example 3. (i) Facts. A university sponsors a group health plan that provides one health benefit package to faculty and another health benefit package to other staff. Faculty and staff are treated differently with respect to other employee benefits such as retirement benefits and leaves of absence. There is no evidence to suggest that the distinction is directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 3, the classification is permitted under this paragraph (d) because there is a distinction based on a bona fide employment-based classification consistent with the employer’s usual business practice and the distinction is not directed at individual participants and beneficiaries.

Example 4. (i) Facts. An employer sponsors a group health plan that is available to all current employees. Former employees may also be eligible, but only if they complete a specified number of years of service, are enrolled under the plan at the time of termination of employment, and are continuously enrolled from that date. There is no evidence to suggest that these distinctions are directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 4, imposing additional eligibility requirements on former employees is permitted because a classification that distinguishes between current and former employees is a bona fide employment-based classification that is permitted under this paragraph (d), provided that it is not directed at individual participants or beneficiaries. In addition, it is permissible to distinguish between former employees who satisfy the service requirement and those who do not, provided that the distinction is not directed at individual participants or beneficiaries. (However, former employees who do not satisfy the eligibility criteria may, nonetheless, be eligible for continued coverage pursuant to a COBRA continuation provision or similar State law.)

Example 5. (i) Facts. An employer sponsors a group health plan that provides the same benefit package to all seven employees of the employer. Six of the seven employees have the same job title and responsibilities, but Employee G has a different job title and different responsibilities. After G files an expensive claim for benefits under the plan, coverage under the plan is modified so that employees with G’s job title receive a different benefit package that includes a lower lifetime dollar limit than in the benefit package made available to the other six employees.

(ii) Conclusion. Under the facts of this Example 5, changing the coverage classification for G based on the existing employment classification for G is not permitted under this paragraph (d) because the creation of the new coverage classification for G is directed at G based on one or more health factors.

(e) Nonconfinement and actively-at-work provisions — (1) Nonconfinement provisions — (i) General rule. Under the rules of paragraphs (b) and (c) of this section, a plan may not establish a rule for eligibility (as described in paragraph (b)(1)(ii) of this section) or set any individual’s premium or contribution rate based on whether an individual is confined to a hospital or other health care institution. In addition, under the rules of paragraphs (b) and (c) of this section, a plan may not establish a rule for eligibility or set any individual’s premium or contribution rate based on an individual’s ability to engage in normal life activities, except to the extent permitted under paragraphs (e)(2)(ii) and (3) of this section (permitting plans, under certain circumstances, to distinguish among employees based on the performance of services).

(ii) Examples. The rules of this paragraph (e)(1) are illustrated by the following examples:

Example 1. (i) Facts. Under a group health plan, coverage for employees and their dependents generally becomes effective on the first day of employment. However, coverage for a dependent who is confined to a hospital or other health care institution does not become effective until the confinement ends.

(ii) Conclusion. In this Example 1, the plan violates this paragraph (e)(1) because the plan delays the effective date of coverage for dependents based on confinement to a hospital or other health care institution.

Example 2. (i) Facts. In previous years, a group health plan has provided coverage through a group health insurance policy offered by Issuer M. However, for the current year, the plan provides coverage through a group health insurance policy offered by Issuer N. Under Issuer N’s policy, items and services provided in connection with the confinement of a dependent to a hospital or other health care institution are not covered if the confinement is covered under an extension of benefits clause from a previous health insurance issuer.

(ii) Conclusion. See Example 2 in 29 CFR 2590.702(e)(1) and 45 CFR 146.121(e)(1) for a conclusion that Issuer N violates provisions of 29 CFR 2590.702(e)(1) and 45 CFR 146.121(e)(1) similar to the provisions of this paragraph (e)(1) because the group health insurance coverage restricts benefits based on whether a dependent is confined to a hospital or other health care institution that is covered under an extension of benefits from a previous issuer. See Example 2 in 29 CFR 2590.702(e)(1) and 45 CFR 146.121(e)(1) for the additional conclusions that under State law Issuer M may also be responsible for providing benefits to such a dependent; and that in a case in which Issuer N has an obligation under 29 CFR 2590.702(e)(1) or 45 CFR 146.121(e)(1) to provide benefits and Issuer M has an obligation under State law to provide benefits, any State laws designed to prevent more than 100% reimbursement, such as State coordination-of-benefits laws, continue to apply.

(2) Actively-at-work and continuous service provisions — (i) General rule. (A) Under the rules of paragraphs (b) and (c) of this section and subject to the exception for the first day of work described in paragraph (e)(2)(ii) of this section, a plan may not establish a rule for eligibility (as described in paragraph (b)(1)(ii) of this section) or set any individual’s premium or contribution rate based on whether an individual is actively at work (including whether an individual is continuously employed), unless absence from work due to any health factor (such as being absent from work on sick leave) is treated, for purposes of the plan, as being actively at work.

(B) The rules of this paragraph (e)(2)(i) are illustrated by the following examples:

Example 1. (i) Facts. Under a group health plan, an employee generally becomes eligible to enroll 30 days after the first day of employment. However, if the employee is not actively at work on the first day after the end of the 30-day period, then eligibility for enrollment is delayed until the first day the employee is actively at work.

(ii) Conclusion. In this Example 1, the plan violates this paragraph (e)(2) (and thus also violates paragraph (b) of this section). However, the plan would not violate paragraph (e)(2) or (b) of this section if, under the plan, an absence due to any health factor is considered being actively at work.

Example 2. (i) Facts. Under a group health plan, coverage for an employee becomes effective after 90 days of continuous service; that is, if an employee is absent from work (for any reason) before completing 90 days of service, the beginning of the 90-day period is measured from the day the employee returns to work (without any credit for service before the absence).

(ii) Conclusion. In this Example 2, the plan violates this paragraph (e)(2) (and thus also paragraph (b) of this section) because the 90-day continuous service requirement is a rule for eligibility based on whether an individual is actively at work. However, the plan would not violate this paragraph (e)(2) or paragraph (b) of this section if, under the plan, an absence due to any health factor is not considered an absence for purposes of measuring 90 days of continuous service.

(ii) Exception for the first day of work. (A) Notwithstanding the general rule in paragraph (e)(2)(i) of this section, a plan may establish a rule for eligibility that requires an individual to begin work for the employer sponsoring the plan (or, in the case of a multiemployer plan, to begin a job in covered employment) before coverage becomes effective, provided that such a rule for eligibility applies regardless of the reason for the absence.

(B) The rules of this paragraph (e)(2)(ii) are illustrated by the following examples:

Example 1. (i) Facts. Under the eligibility provision of a group health plan, coverage for new employees becomes effective on the first day that the employee reports to work. Individual H is scheduled to begin work on August 3. However, H is unable to begin work on that day because of illness. H begins working on August 4, and H’s coverage is effective on August 4.

(ii) Conclusion. In this Example 1, the plan provision does not violate this section. However, if coverage for individuals who do not report to work on the first day they were scheduled to work for a reason unrelated to a health factor (such as vacation or bereavement) becomes effective on the first day they were scheduled to work, then the plan would violate this section.

Example 2. (i) Facts. Under a group health plan, coverage for new employees becomes effective on the first day of the month following the employee’s first day of work, regardless of whether the employee is actively at work on the first day of the month. Individual J is scheduled to begin work on March 24. However, J is unable to begin work on March 24 because of illness. J begins working on April 7 and J’s coverage is effective May 1.

(ii) Conclusion. In this Example 2, the plan provision does not violate this section. However, as in Example 1, if coverage for individuals absent from work for reasons unrelated to a health factor became effective despite their absence, then the plan would violate this section.

(3) Relationship to plan provisions defining similarly situated individuals. (i) Notwithstanding the rules of paragraphs (e)(1) and (2) of this section, a plan may establish rules for eligibility or set any individual’s premium or contribution rate in accordance with the rules relating to similarly situated individuals in paragraph (d) of this section. Accordingly, a plan may distinguish in rules for eligibility under the plan between full-time and part-time employees, between permanent and temporary or seasonal employees, between current and former employees, and between employees currently performing services and employees no longer performing services for the employer, subject to paragraph (d) of this section. However, other Federal or State laws (including the COBRA continuation provisions and the Family and Medical Leave Act of 1993) may require an employee or the employee’s dependents to be offered coverage and set limits on the premium or contribution rate even though the employee is not performing services.

(ii) The rules of this paragraph (e)(3) are illustrated by the following examples:

Example 1. (i) Facts. Under a group health plan, employees are eligible for coverage if they perform services for the employer for 30 or more hours per week or if they are on paid leave (such as vacation, sick, or bereavement leave). Employees on unpaid leave are treated as a separate group of similarly situated individuals in accordance with the rules of paragraph (d) of this section.

(ii) Conclusion. In this Example 1, the plan provisions do not violate this section. However, if the plan treated individuals performing services for the employer for 30 or more hours per week, individuals on vacation leave, and individuals on bereavement leave as a group of similarly situated individuals separate from individuals on sick leave, the plan would violate this paragraph (e) (and thus also would violate paragraph (b) of this section) because groups of similarly situated individuals cannot be established based on a health factor (including the taking of sick leave) under paragraph (d) of this section.

Example 2. (i) Facts. To be eligible for coverage under a bona fide collectively bargained group health plan in the current calendar quarter, the plan requires an individual to have worked 250 hours in covered employment during the three-month period that ends one month before the beginning of the current calendar quarter. The distinction between employees working at least 250 hours and those working less than 250 hours in the earlier three-month period is not directed at individual participants or beneficiaries based on any health factor of the participants or beneficiaries.

(ii) Conclusion. In this Example 2, the plan provision does not violate this section because, under the rules for similarly situated individuals allowing full-time employees to be treated differently than part-time employees, employees who work at least 250 hours in a three-month period can be treated differently than employees who fail to work 250 hours in that period. The result would be the same if the plan permitted individuals to apply excess hours from previous periods to satisfy the requirement for the current quarter.

Example 3. (i) Facts. Under a group health plan, coverage of an employee is terminated when the individual’s employment is terminated, in accordance with the rules of paragraph (d) of this section. Employee B has been covered under the plan. B experiences a disabling illness that prevents B from working. B takes a leave of absence under the Family and Medical Leave Act of 1993. At the end of such leave, B terminates employment and consequently loses coverage under the plan. (This termination of coverage is without regard to whatever rights the employee (or members of the employee’s family) may have for COBRA continuation coverage.)

(ii) Conclusion. In this Example 3, the plan provision terminating B’s coverage upon B’s termination of employment does not violate this section.

Example 4. (i) Facts. Under a group health plan, coverage of an employee is terminated when the employee ceases to perform services for the employer sponsoring the plan, in accordance with the rules of paragraph (d) of this section. Employee C is laid off for three months. When the layoff begins, C’s coverage under the plan is terminated. (This termination of coverage is without regard to whatever rights the employee (or members of the employee’s family) may have for COBRA continuation coverage.)

(ii) Conclusion. In this Example 4, the plan provision terminating C’s coverage upon the cessation of C’s performance of services does not violate this section.

(f) Wellness programs. A wellness program is any program designed to promote health or prevent disease. Paragraphs (b)(2)(ii) and (c)(3) of this section provide exceptions to the general prohibitions against discrimination based on a health factor for plan provisions that vary benefits (including cost-sharing mechanisms) or the premium or contribution for similarly situated individuals in connection with a wellness program that satisfies the requirements of this paragraph (f). If none of the conditions for obtaining a reward under a wellness program is based on an individual satisfying a standard that is related to a health factor, paragraph (f)(1) of this section clarifies that the wellness program does not violate this section if participation in the program is made available to all similarly situated individuals. If any of the conditions for obtaining a reward under a wellness program is based on an individual satisfying a standard that is related to a health factor, the wellness program does not violate this section if the requirements of paragraph (f)(2) of this section are met.

(1) Wellness programs not subject to requirements. If none of the conditions for obtaining a reward under a wellness program is based on an individual satisfying a standard that are related to a health factor (or if a wellness program does not provide a reward), the wellness program does not violate this section, if participation in the program is made available to all similarly situated individuals. Thus, for example, the following programs need not satisfy the requirements of paragraph (f)(2) of this section, if participation in the program is made available to all similarly situated individuals:

(i) A program that reimburses all or part of the cost for memberships in a fitness center.

(ii) A diagnostic testing program that provides a reward for participation and does not base any part of the reward on outcomes.

(iii) A program that encourages preventive care through the waiver of the copayment or deductible requirement under a group health plan for the costs of, for example, prenatal care or well-baby visits.

(iv) A program that reimburses employees for the costs of smoking cessation programs without regard to whether the employee quits smoking.

(v) A program that provides a reward to employees for attending a monthly health education seminar.

(2) Wellness programs subject to requirements. If any of the conditions for obtaining a reward under a wellness program are based on an individual satisfying a standard that is related to a health factor, the wellness program does not violate this section if the requirements of this paragraph (f)(2) are met.

(i) The reward for the wellness program, coupled with the reward for other wellness programs with respect to the plan that require satisfaction of a standard related to a health factor, must not exceed 20 percent of the cost of employee-only coverage under the plan. However, if, in addition to employees, any class of dependents (such as spouses or spouses and dependent children) may participate in the wellness program, the reward must not exceed 20 percent of the cost of the coverage in which an employee and any dependents are enrolled. For purposes of this paragraph (f)(2), the cost of coverage is determined based on the total amount of employer and employee contributions for the benefit package under which the employee is (or the employee and any dependents are) receiving coverage. A reward can be in the form of a discount or rebate of a premium or contribution, a waiver of all or part of a cost-sharing mechanism (such as deductibles, copayments, or coinsurance), the absence of a surcharge, or the value of a benefit that would otherwise not be provided under the plan.

(ii) The program must be reasonably designed to promote health or prevent disease. A program satisfies this standard if it has a reasonable chance of improving the health of or preventing disease in participating individuals and it is not overly burdensome, is not a subterfuge for discriminating based on a health factor, and is not highly suspect in the method chosen to promote health or prevent disease.

(iii) The program must give individuals eligible for the program the opportunity to qualify for the reward under the program at least once per year.

(iv) The reward under the program must be available to all similarly situated individuals.

(A) A reward is not available to all similarly situated individuals for a period unless the program allows —

(1) A reasonable alternative standard (or waiver of the otherwise applicable standard) for obtaining the reward for any individual for whom, for that period, it is unreasonably difficult due to a medical condition to satisfy the otherwise applicable standard; and

(2) A reasonable alternative standard (or waiver of the otherwise applicable standard) for obtaining the reward for any individual for whom, for that period, it is medically inadvisable to attempt to satisfy the otherwise applicable standard.

(B) A plan or issuer may seek verification, such as a statement from an individual’s physician, that a health factor makes it unreasonably difficult or medically inadvisable for the individual to satisfy or attempt to satisfy the otherwise applicable standard.

(v) (A) The plan must disclose in all plan materials describing the terms of the program the availability of a reasonable alternative standard (or the possibility of waiver of the otherwise applicable standard) required under paragraph (f)(2)(iv) of this section. However, if plan materials merely mention that a program is available, without describing its terms, this disclosure is not required.

(B) The following language, or substantially similar language, can be used to satisfy the requirement of this paragraph (f)(2)(v): “If it is unreasonably difficult due to a medical condition for you to achieve the standards for the reward under this program, or if it is medically inadvisable for you to attempt to achieve the standards for the reward under this program, call us at [insert telephone number] and we will work with you to develop another way to qualify for the reward.” In addition, other examples of language that would satisfy this requirement are set forth in Examples 3, 4, and 5 of paragraph (f)(3) of this section.

(3) Examples. The rules of paragraph (f)(2) of this section are illustrated by the following examples:

Example 1. (i) Facts. An employer sponsors a group health plan. The annual premium for employee-only coverage is $3,600 (of which the employer pays $2,700 per year and the employee pays $900 per year). The annual premium for family coverage is $9,000 (of which the employer pays $4,500 per year and the employee pays $4,500 per year). The plan offers a wellness program with an annual premium rebate of $360. The program is available only to employees.

(ii) Conclusion. In this Example 1, the program satisfies the requirements of paragraph (f)(2)(i) of this section because the reward for the wellness program, $360, does not exceed 20 percent of the total annual cost of employee-only coverage, $720. ($3,600 x 20% = $720.) If any class of dependents is allowed to participate in the program and the employee is enrolled in family coverage, the plan could offer the employee a reward of up to 20 percent of the cost of family coverage, $1,800. ($9,000 x 20% = $1,800.)

Example 2. (i) Facts. A group health plan gives an annual premium discount of 20 percent of the cost of employee-only coverage to participants who adhere to a wellness program. The wellness program consists solely of giving an annual cholesterol test to participants. Those participants who achieve a count under 200 receive the premium discount for the year.

(ii) Conclusion. In this Example 2, the program fails to satisfy the requirement of being available to all similarly situated individuals because some participants may be unable to achieve a cholesterol count of under 200 and the plan does not make available a reasonable alternative standard or waive the cholesterol standard. (In addition, plan materials describing the program are required to disclose the availability of a reasonable alternative standard (or the possibility of waiver of the otherwise applicable standard) for obtaining the premium discount. Thus, the premium discount violates paragraph (c) of this section because it may require an individual to pay a higher premium based on a health factor of the individual than is required of a similarly situated individual under the plan.

Example 3. (i) Facts. Same facts as Example 2, except that the plan provides that if it is unreasonably difficult due to a medical condition for a participant to achieve the targeted cholesterol count (or if it is medically inadvisable for a participant to attempt to achieve the targeted cholesterol count) within a 60-day period, the plan will make available a reasonable alternative standard that takes the relevant medical condition into account. In addition, all plan materials describing the terms of the program include the following statement: “If it is unreasonably difficult due to a medical condition for you to achieve a cholesterol count under 200, or if it is medically inadvisable for you to attempt to achieve a count under 200, call us at the number below and we will work with you to develop another way to get the discount.” Individual D begins a diet and exercise program but is unable to achieve a cholesterol count under 200 within the prescribed period. D’s doctor determines D requires prescription medication to achieve a medically advisable cholesterol count. In addition, the doctor determines that D must be monitored through periodic blood tests to continually reevaluate D’s health status. The plan accommodates D by making the discount available to D, but only if D follows the advice of D’s doctor’s regarding medication and blood tests.

(ii) Conclusion. In this Example 3, the program is a wellness program because it satisfies the five requirements of paragraph (f)(2) of this section. First, the program complies with the limits on rewards under a program. Second, it is reasonably designed to promote health or prevent disease. Third, individuals eligible for the program are given the opportunity to qualify for the reward at least once per year. Fourth, the reward under the program is available to all similarly situated individuals because it accommodates individuals for whom it is unreasonably difficult due to a medical condition to achieve the targeted count (or for whom it is medically inadvisable to attempt to achieve the targeted count) in the prescribed period by providing a reasonable alternative standard. Fifth, the plan discloses in all materials describing the terms of the program the availability of a reasonable alternative standard. Thus, the premium discount does not violate this section.

Example 4. (i) Facts. A group health plan will waive the $250 annual deductible (which is less than 20 percent of the annual cost of employee-only coverage under the plan) for the following year for participants who have a body mass index between 19 and 26, determined shortly before the beginning of the year. However, any participant for whom it is unreasonably difficult due to a medical condition to attain this standard (and any participant for whom it is medically inadvisable to attempt to achieve this standard) during the plan year is given the same discount if the participant walks for 20 minutes three days a week. Any participant for whom it is unreasonably difficult due to a medical condition to attain either standard (and any participant for whom it is medically inadvisable to attempt to achieve either standard) during the year is given the same discount if the individual satisfies an alternative standard that is reasonable in the burden it imposes and is reasonable taking into consideration the individual’s medical situation. All plan materials describing the terms of the wellness program include the following statement: “If it is unreasonably difficult due to a medical condition for you to achieve a body mass index between 19 and 26 (or if it is medically inadvisable for you to attempt to achieve this body mass index) this year, your deductible will be waived if you walk for 20 minutes three days a week. If you cannot follow the walking program, call us at the number above and we will work with you to develop another way to have your deductible waived.” Due to a medical condition, Individual E is unable to achieve a BMI of between 19 and 26 and is also unable to follow the walking program. E proposes a program based on the recommendations of E’s physician. The plan agrees to make the discount available to E if E follows the physician’s recommendations.

(ii) Conclusion. In this Example 4, the program satisfies the five requirements of paragraph (f)(2) of this section. First, the program complies with the limits on rewards under a program. Second, it is reasonably designed to promote health or prevent disease. Third, individuals eligible for the program are given the opportunity to qualify for the reward at least once per year. Fourth, the reward under the program is available to all similarly situated individuals because it generally accommodates individuals for whom it is unreasonably difficult due to a medical condition to achieve (or for whom it is medically inadvisable to attempt to achieve) the targeted body mass index by providing a reasonable alternative standard (walking) and it accommodates individuals for whom it is unreasonably difficult due to a medical condition (or for whom it is medically inadvisable to attempt) to walk by providing an alternative standard that is reasonable for the individual. Fifth, the plan discloses in all materials describing the terms of the program the availability of a reasonable alternative standard for every individual. Thus, the waiver of the deductible does not violate this section.

Example 5. (i) Facts. In conjunction with an annual open enrollment period, a group health plan provides a form for participants to certify that they have not used tobacco products in the preceding twelve months. Participants who do not provide the certification are assessed a surcharge that is 20 percent of the cost of employee-only coverage. However, all plan materials describing the terms of the wellness program include the following statement: “If it is unreasonably difficult due to a health factor for you to meet the requirements under this program (or if it is medically inadvisable for you to attempt to meet the requirements of this program), we will make available a reasonable alternative standard for you to avoid this surcharge.” It is unreasonably difficult for Individual F to stop smoking cigarettes due to an addiction to nicotine (a medical condition). The plan accommodates F by requiring F to participate in a smoking cessation program to avoid the surcharge. F can avoid the surcharge for as long as F participates in the program, regardless of whether F stops smoking (as long as F continues to be addicted to nicotine).

(ii) Conclusion. In this Example 5, the premium surcharge is permissible as a wellness program because it satisfies the five requirements of paragraph (f)(2) of this section. First, the program complies with the limits on rewards under a program. Second, it is reasonably designed to promote health or prevent disease. Third, individuals eligible for the program are given the opportunity to qualify for the reward at least once per year. Fourth, the reward under the program is available to all similarly situated individuals because it accommodates individuals for whom it is unreasonably difficult due to a medical condition (or for whom it is medically inadvisable to attempt) to quit using tobacco products by providing a reasonable alternative standard. Fifth, the plan discloses in all materials describing the terms of the program the availability of a reasonable alternative standard. Thus, the premium surcharge does not violate this section.

Example 6. (i) Facts. Same facts as Example 5, except the plan accommodates F by requiring F to view, over a period of 12 months, a 12-hour video series on health problems associated with tobacco use. F can avoid the surcharge by complying with this requirement.

(ii) Conclusion. In this Example 6, the requirement to watch the series of video tapes is a reasonable alternative method for avoiding the surcharge.

(g) More favorable treatment of individuals with adverse health factors permitted — (1) In rules for eligibility. (i) Nothing in this section prevents a group health plan from establishing more favorable rules for eligibility (described in paragraph (b)(1) of this section) for individuals with an adverse health factor, such as disability, than for individuals without the adverse health factor. Moreover, nothing in this section prevents a plan from charging a higher premium or contribution with respect to individuals with an adverse health factor if they would not be eligible for the coverage were it not for the adverse health factor. (However, other laws, including State insurance laws, may set or limit premium rates; these laws are not affected by this section.)

(ii) The rules of this paragraph (g)(1) are illustrated by the following examples:

Example 1. (i) Facts. An employer sponsors a group health plan that generally is available to employees, spouses of employees, and dependent children until age 23. However, dependent children who are disabled are eligible for coverage beyond age 23.

(ii) Conclusion. In this Example 1, the plan provision allowing coverage for disabled dependent children beyond age 23 satisfies this paragraph (g)(1) (and thus does not violate this section).

Example 2. (i) Facts. An employer sponsors a group health plan, which is generally available to employees (and members of the employee’s family) until the last day of the month in which the employee ceases to perform services for the employer. The plan generally charges employees $50 per month for employee-only coverage and $125 per month for family coverage. However, an employee who ceases to perform services for the employer by reason of disability may remain covered under the plan until the last day of the month that is 12 months after the month in which the employee ceased to perform services for the employer. During this extended period of coverage, the plan charges the employee $100 per month for employee-only coverage and $250 per month for family coverage. (This extended period of coverage is without regard to whatever rights the employee (or members of the employee’s family) may have for COBRA continuation coverage.)

(ii) Conclusion. In this Example 2, the plan provision allowing extended coverage for disabled employees and their families satisfies this paragraph (g)(1) (and thus does not violate this section). In addition, the plan is permitted, under this paragraph (g)(1), to charge the disabled employees a higher premium during the extended period of coverage.

Example 3. (i) Facts. To comply with the requirements of a COBRA continuation provision, a group health plan generally makes COBRA continuation coverage available for a maximum period of 18 months in connection with a termination of employment but makes the coverage available for a maximum period of 29 months to certain disabled individuals and certain members of the disabled individual’s family. Although the plan generally requires payment of 102 percent of the applicable premium for the first 18 months of COBRA continuation coverage, the plan requires payment of 150 percent of the applicable premium for the disabled individual’s COBRA continuation coverage during the disability extension if the disabled individual would not be entitled to COBRA continuation coverage but for the disability.

(ii) Conclusion. In this Example 3, the plan provision allowing extended COBRA continuation coverage for disabled individuals satisfies this paragraph (g)(1) (and thus does not violate this section). In addition, the plan is permitted, under this paragraph (g)(1), to charge the disabled individuals a higher premium for the extended coverage if the individuals would not be eligible for COBRA continuation coverage were it not for the disability. (Similarly, if the plan provided an extended period of coverage for disabled individuals pursuant to State law or plan provision rather than pursuant to a COBRA continuation coverage provision, the plan could likewise charge the disabled individuals a higher premium for the extended coverage.)

(2) In premiums or contributions. (i) Nothing in this section prevents a group health plan from charging individuals a premium or contribution that is less than the premium (or contribution) for similarly situated individuals if the lower charge is based on an adverse health factor, such as disability.

(ii) The rules of this paragraph (g)(2) are illustrated by the following example:

Example. (i) Facts. Under a group health plan, employees are generally required to pay $50 per month for employee-only coverage and $125 per month for family coverage under the plan. However, employees who are disabled receive coverage (whether employee-only or family coverage) under the plan free of charge.

(ii) Conclusion. In this Example, the plan provision waiving premium payment for disabled employees is permitted under this paragraph (g)(2) (and thus does not violate this section).

(h) No effect on other laws. Compliance with this section is not determinative of compliance with any provision of ERISA (including the COBRA continuation provisions) or any other State or Federal law, such as the Americans with Disabilities Act. Therefore, although the rules of this section would not prohibit a plan from treating one group of similarly situated individuals differently from another (such as providing different benefit packages to current and former employees), other Federal or State laws may require that two separate groups of similarly situated individuals be treated the same for certain purposes (such as making the same benefit package available to COBRA qualified beneficiaries as is made available to active employees). In addition, although this section generally does not impose new disclosure obligations on plans, this section does not affect any other laws, including those that require accurate disclosures and prohibit intentional misrepresentation.

(i) Applicability dates. This section applies for plan years beginning on or after July 1, 2007.

Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.

Approved June 22, 2006.

Eric Solomon,
Acting Deputy Assistant Secretary
of the Treasury (Tax Policy).

(a) Statutory basis. Sections 54.9801-1 through 54.9801-6, 54.9802-1, 54.9802-2, 54.9811-1T, 54.9812-1T, 54.9831-1, and 54.9833-1 (portability sections) implement Chapter 100 of Subtitle K of the Internal Revenue Code of 1986.

* * * * *

Par. 3. In §54.9801-2, the introductory text is amended to read as follows:

Unless otherwise provided, the definitions in this section govern in applying the provisions of §§54.9801-1 through 54.9801-6, 54.9802-1, 54.9802-2, 54.9811-1T, 54.9812-1T, 54.9831-1, and 54.9833-1.

*****

Par. 4. Section 54.9802-2 is added to read as follows:

(a) Exception for certain church plans—(1) Church plans in general. A church plan described in paragraph (b) of this section is not treated as failing to meet the requirements of section 9802 or §54.9802-1 solely because the plan requires evidence of good health for coverage of individuals under plan provisions described in paragraph (b)(2) or (3) of this section.

(2) Health insurance issuers. See sections 2702 and 2721(b)(1)(B) of the Public Health Service Act (42 U.S.C. 300gg-2 and 300gg-21(b)(1)(B)) and 45 CFR 146.121, which require health insurance issuers providing health insurance coverage under a church plan that is a group health plan to comply with nondiscrimination requirements similar to those that church plans are required to comply with under section 9802 and §54.9802-1 except that those nondiscrimination requirements do not include an exception for health insurance issuers comparable to the exception for church plans under section 9802(c) and this section.

(b) Church plans to which this section applies—(1) Church plans with certain coverage provisions in effect on July 15, 1997. This section applies to any church plan (as defined in section 414(e)) for a plan year if, on July 15, 1997 and at all times thereafter before the beginning of the plan year, the plan contains either the provisions described in paragraph (b)(2) of this section or the provisions described in paragraph (b)(3) of this section.

(2) Plan provisions applicable to individuals employed by employers of 10 or fewer employees and self-employed individuals. (i) A plan contains the provisions described in this paragraph (b)(2) if it requires evidence of good health of both —

(A) Any employee of an employer of 10 or fewer employees (determined without regard to section 414(e)(3)(C), under which a church or convention or association of churches is treated as the employer); and

(B) Any self-employed individual.

(ii) A plan does not contain the provisions described in this paragraph (b)(2) if the plan contains only one of the provisions described in this paragraph (b)(2). Thus, for example, a plan that requires evidence of good health of any self-employed individual, but not of any employee of an employer with 10 or fewer employees, does not contain the provisions described in this paragraph (b)(2). Moreover, a plan does not contain the provision described in paragraph (b)(2)(i)(A) of this section if the plan requires evidence of good health of any employee of an employer of fewer than 10 (or greater than 10) employees. Thus, for example, a plan does not contain the provision described in paragraph (b)(2)(i)(A) of this section if the plan requires evidence of good health of any employee of an employer with five or fewer employees.

(3) Plan provisions applicable to individuals who enroll after the first 90 days of initial eligibility. (i) A plan contains the provisions described in this paragraph (b)(3) if it requires evidence of good health of any individual who enrolls after the first 90 days of initial eligibility under the plan.

(ii) A plan does not contain the provisions described in this paragraph (b)(3) if it provides for a longer (or shorter) period than 90 days. Thus, for example, a plan requiring evidence of good health of any individual who enrolls after the first 120 days of initial eligibility under the plan does not contain the provisions described in this paragraph (b)(3).

(c) Examples. The rules of this section are illustrated by the following examples:

Example 1. (i) Facts. A church organization maintains two church plans for entities affiliated with the church. One plan is a group health plan that provides health coverage to all employees (including ministers and lay workers) of any affiliated church entity that has more than 10 employees. The other plan is Plan O, which is a group health plan that is not funded through insurance coverage and that provides health coverage to any employee (including ministers and lay workers) of any affiliated church entity that has 10 or fewer employees and any self-employed individual affiliated with the church (including a self-employed minister of the church). Plan O requires evidence of good health in order for any individual of a church entity that has 10 or fewer employees to be covered and in order for any self-employed individual to be covered. On July 15, 1997 and at all times thereafter before the beginning of the plan year, Plan O has contained all the preceding provisions.

(ii) Conclusion. In this Example 1, because Plan O contains the plan provisions described in paragraph (b)(2) of this section and because those provisions were in the plan on July 15, 1997 and at all times thereafter before the beginning of the plan year, Plan O will not be treated as failing to meet the requirements of section 9802 or §54.9802-1 for the plan year solely because the plan requires evidence of good health for coverage of the individuals described in those plan provisions.

Example 2. (i) Facts. A church organization maintains Plan P, which is a church plan that is not funded through insurance coverage and that is a group health plan providing health coverage to individuals employed by entities affiliated with the church and self-employed individuals affiliated with the church (such as ministers). On July 15, 1997 and at all times thereafter before the beginning of the plan year, Plan P has required evidence of good health for coverage of any individual who enrolls after the first 90 days of initial eligibility under the plan.

(ii) Conclusion. In this Example 2, because Plan P contains the plan provisions described in paragraph (b)(3) of this section and because those provisions were in the plan on July 15, 1997 and at all times thereafter before the beginning of the plan year, Plan P will not be treated as failing to meet the requirements of section 9802 or §54.9802-1 for the plan year solely because the plan requires evidence of good health for coverage of individuals enrolling after the first 90 days of initial eligibility under the plan.

(d) Effective date. This section is applicable to plan years beginning on or after July 1, 2007.

Par. 5. Section 54.9831-1 is amended by revising paragraphs (b) and (c)(1) to read as follows:

*****

(b) General exception for certain small group health plans. The requirements of §§54.9801-1 through 54.9801-6, 54.9802-1, 54.9802-2, 54.9811-1T, 54.9812-1T, and 54.9833-1 do not apply to any group health plan for any plan year if, on the first day of the plan year, the plan has fewer than two participants who are current employees.

(c) Excepted benefits — (1) In general. The requirements of §§54.9801-1 through 54.9801-6, 54.9802-1, 54.9802-2, 54.9811-1T, 54.9812-1T, and 54.9833-1 do not apply to any group health plan in relation to its provision of the benefits described in paragraph (c)(2), (3), (4), or (5) of this section (or any combination of these benefits).

* * * * *

Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.

Approved June 22, 2006.

Eric Solomon,
Acting Deputy Assistant Secretary
of the Treasury (Tax Policy).

[The text of the proposed amendment to §1.1502-43 is the same as the text for §1.1502-43T published elsewhere in this issue of the Bulletin].

Par. 3. Section 1.1502-47 is amended by revising paragraph (s) and adding paragraph (t) to read as follows:

[The text of the proposed amendment to §1.1502-47 is the same as the text for §1.1502-47T published elsewhere in this issue of the Bulletin].

Par. 4. Section 1.1561-1 is added to read as follows:

[The text of the proposed §1.1561-1 is the same as the text for §1.1561-1T published elsewhere in this issue of the Bulletin].

Par. 5. Section 1.1561-2 is amended by revising paragraphs (a), (b), (c) and (d) and adding paragraph (f) to read as follows:

[The text of the proposed amendment to §1.1561-2 is the same as the text for 1.1561-2T published elsewhere in this issue of the Bulletin].

Par. 6. Section 1.1561-3 is added to read as follows:

[The text of the proposed §1.1561-3 is the same as the text for §1.1561-3T published elsewhere in this issue of the Bulletin].

Par. 7. Section 1.1563-1 is added to read as follows:

[The text of the proposed §1.1563-1 is the same as the text for §1.1563-1T published elsewhere in this issue of the Bulletin].

Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.