The following explanation was provided by Arthur Meyers, a partner at the law firm of Choate, Hall & Stewart LLP.

Many employers are not aware that they (and in some cases their executives) risk incurring huge taxes for providing subsidized health coverage to former highly-compensated employees as part of a separation or severance agreement.

For many years section 105(h) of the Tax Code has prohibited this practice for self-insured plans unless the employer imputes the amount of the health insurance “premium” as taxable income to the former highly-compensated employee. If the employer does not do so then the former executive has income equal to the value of the health care provider and hospital services reimbursed by the plan (e.g. the value of the heart by-pass surgery). Some employers avoided imputing taxable income by adopting so-called insurance carve-out plans to provide the same health benefits as the self-insured plan but on a fully insured basis thus allowing executives to avoid taxation of the coverage. That strategy no longer works due to the recent health care reform law discussed below.

If a group health plan is insured, then section 2716 of the Affordable Care Act imposes an excise tax on the employer for providing discriminatory coverage to former highly-compensated employees of up to $500,000 per year.  (The tax is $100 per day for each non-highly compensated person not receiving the company-subsidized post-termination coverage.) The IRS issued a moratorium in 2011 on collecting the excise tax but that reprieve is expected to be lifted perhaps as early as 2014.

Although there is an exception under section 2716 for “retirees” that might be available under certain circumstances, employers are moving toward providing cash payments to former highly-compensated employees instead. Those payments must be made in compliance with section 409A of the Tax Code. It is not clear what will happen to employers who have already promised such coverage in a binding agreement.

Bottom line: It doesn’t make sense for an employer to enter into any new agreements that require it to provide subsidized health insurance after termination of employment.

Additional information:  http://www.irs.gov/irb/2011-02_IRB/ar10.html;  http://www.irs.gov/pub/irs-drop/n-10-63.pdf;  http://www.irs.gov/pub/irs-drop/n-11-01.pdf;  https://www.aetna.com/health-reform-connection/questions-answers/non-discrimination.html