WA Cares Act Update: Federal Court Dismisses Lawsuit, Holding Premiums Are State Taxes and Case Must Be Litigated in State Court

On April 25, 2022, Judge Thomas Zilly of the U.S. District Court for the Western District of Washington dismissed a class action lawsuit that had been filed in federal court by DWT on behalf of employers and employees challenging the Washington Cares Act (WA Cares) premium assessed at the rate of .58 percent of wages. The lawsuit contended that the Act violated ERISA and other federal laws.

In addition to the ERISA issue, the lawsuit focused on a number of inequities—in particular, older individuals within 10 years of retirement and out-of-state residents who worked for a Washington state employer would pay the premium but would receive no benefits. Employees who paid the premium for their entire working career and then retired out of state would also receive no benefit. The lawsuit drew the legislature's attention to the problems with WA Cares and the legislature rushed to enact partial fixes and delayed the premium withholding until July 2023, as explained more fully below.

Judge Zilly dismissed the plaintiffs' federal case holding that the premium charged against an employee's wages was a tax and not an insurance premium. As a state tax, the federal court could not hear the case because the federal court lacks jurisdiction under the Tax Injunction Act, i.e., state courts have exclusive jurisdiction over challenges to state taxes. In addition, although not raised by the state in its motion, the court independently held that WA Cares premiums were not maintained by an employer and, therefore, not subject to ERISA.

The dismissal shifts the litigation from the federal court to the state court and adds a new state law challenge of WA Cares: Is the WA Cares premium a state income tax assessed on employee wages and, therefore, unconstitutional under Washington state law? The federal court's dismissal and the status of WA Cares due to the 2022 legislative changes are discussed below.

The Federal Court's Dismissal

The state filed a motion to dismiss the federal lawsuit on the basis that the WA Cares premium, although called an insurance premium, was actually a tax imposed on employees' wages. If the premium is a tax, the federal court would lack jurisdiction as state tax challenges must be brought in state court.

Whether the assessment is a tax or premium for insurance is determined by federal law. The courts review three factors to make that determination, those being whether the assessment:

• 1. Was made by the legislature;
• 2. Is imposed on a broad group of individuals; and
• 3. Was made for the social welfare of the state.

When applying these factors, plaintiffs argued that the court's focus should be on the legislation at the time of enactment and not how many people ultimately purchased long-term care insurance from the state. At the time of enactment, the assessment was not mandatorily imposed on anyone, because everyone had the right to opt-out by buying long-term care insurance from a private insurance carrier. Also, the state actively marketed long-term care as an insurance product and the assessment as a premium since the law was enacted in July of 2019.

As to the social benefit, plaintiffs argued there is only an ancillary social benefit achieved by the insurance and that is the same benefit for any insurance product, such as disability or automobile insurance. The court disagreed and applied the factors as of the date of the hearing and found all three factors satisfied as: 1) WA Cares was passed by the legislature; 2) while individuals could apply for exemptions, approximately 3 million people remain subject to WA Cares and 3 million employees is a broad group of individuals; and 3) the long-term care insurance had a social welfare purpose of potential Medicaid savings, noting that WA cares is predicted to save the Medicaid program $898,000,000 in 2051-2053.

While not raised by the state's motion to dismiss, the federal court, on its own, raised the issue of whether WA Cares was "maintained or established" by an employer as required to be subject to ERISA. The court found that WA Cares was enacted by the legislature and, therefore, was not a creation of an employer.

While the court did not deal specifically with whether the state is "maintaining" the program for its employees, it suggested that the maintenance requirement is not met because employees can accrue a benefit if the employee leaves the state and works for a private employer. Because the employee can accrue benefits while employed with other employers, the court suggested that the state is not maintaining the program for its employees.

In other words, the federal court suggested that ERISA can only be applied if all the service is being performed for a single employer. The court's analysis overlooked the fact that ERISA specifically covers multiple-employer pension and welfare arrangements. By definition a multiple-employer plan would cover service with various employers and the court's opinion would appear contrary to these specific code provisions that allow for multiple-employer arrangements.

What Does the Dismissal Mean for the Future of WA Cares?

The dismissal means the end to an ERISA challenge in federal court. However, the court notes in footnote 22 of its opinion that plaintiffs may likely challenge WA Cares as violating Article VII, Section 1 of the Washington Constitution that requires all taxes to be "uniform upon the same class of property within the territorial limits of the authority levying the tax."

The dismissal thus set the stage to challenge WA Cares as an unconstitutional income tax imposed on employees receiving wages in the state. The state may respond that the Washington Constitution is not violated because the state maintains that WA Cares is an "excise tax" and not an income tax.

In the very recent case of Quinn/Clayton v. the State of Washington, the state argued the new 2022 capital gains tax was an "excise tax" and not an income tax. The Douglas County Superior Court disagreed, finding that the new capital gains tax was an income tax. The logic of Quinn/Clayton may indicate that WA Cares is an income tax.

As an income tax, as noted by the federal court, the tax must be uniform across all tax taxpayers. The WA Cares opt-out provisions and the exclusion of self-employed individuals may mean that the tax is not uniform. In 1951, the Washington Supreme Court decided the case of Power, Inc. v. Huntley, 39 Wn. 2d. 191(1951). In 2019, the Court of Appeals in Kunath v. City of Seattle, 10 Wn App. 2d 205 (2019), cited the case with approval and the Kunath decision was also noted by federal court in WA Cares.

Huntley involved a "corporate excise tax" of 4 percent of a corporation's net income. The Huntley case held that the tax was not an excise tax, as labeled by the state, but rather it was an income tax. As an income tax it violated Article VII, Section 1 of the state constitution as it affected only some forms of corporations and not others.

Under WA Cares, approximately 470,000 individuals are permanently exempt from coverage by the purchase of insurance from a private carrier, another 200,000 individuals are exempt under the statute and approximately 230,000 self-employed individuals have the optional right to opt into WA Cares.

WA Cares could, therefore, be found to violate the uniformity clause of the state constitution, as it is not applicable to LLCs and self-employed individuals and has a number of other opt-out provisions, enabling approximately 900,000 Washington state wage earners to avoid the tax altogether.

2022 Legislative Changes to WA Cares

The premium withholding from employees' wages was scheduled to go into effect on January 1, 2022. But due to concerns raised by the federal lawsuit, the legislature rushed to fix certain problem areas of the program.

On January 26, 2022, after the premium withholding had been in effect for the first payroll period in January, the legislature passed House Bill 1732 and House Bill 1733, both of which took effect immediately after being signed by Governor Inslee on January 27, 2022. The relevant changes to WA Cares are as follows:

House Bill 1732

1. Delay of further premium withholding and return of premiums previously withheld.

The law delayed the date for any further premium collection from January 1, 2022, to July 1, 2023, and gave the employer 120 days from the date of the withholding of the premium to return the premium to the employee if the premium had not been remitted to the Employment Security Department (ESD).

If the premium had been remitted to the ESD, the Department had 120 days to return the premium to the employer who then in turn must refund the premium to the employee. These time periods may not be in compliance with federal law, which would mandate the return of the premium as soon as reasonably possible, but no later than seven days from the enactment of this legislation.

2. Limited relief to employees within 10 years of retirement.

For individuals born before January 1, 1968, an individual may qualify for a WA Cares benefit if the individual paid the premium for at least one year. Such an individual is entitled to 10 percent of the benefit for each year the individual has paid the premium.

This provision added some, but not complete, protection for older workers, as those who begin working in the state after attaining the age of 55 and who were born after January 1, 1968, will still not be entitled to a benefit if such workers do not have 10 years of premium payment.

This provision will also add an additional cost of .03 percent to a premium that is already capped at .58 percent and underfunded.

3. Delayed effective date for the payment of benefits.

The payment of any benefits under WA Cares was delayed from January 1, 2025, for 18 months until July 1, 2026.

House Bill 1733

Extension of opt-out provision.

The law allows a new group of individuals to apply for an exemption from the premium payment regardless of whether such individuals have private long-term care insurance. This new group includes:

• Veterans with a service-connected disability of 70 percent or higher;
• Spouses or domestic partners of active-duty service members;
• Persons residing outside of Washington state while working in Washington; and
• Persons working in the United States under a temporary, nonimmigrant work visa.

The exemption, however, will be discontinued within 90 days of employee no longer meeting the requirements for the exemption. For example, the out-of-state exemption will no longer be applicable 90 days after the employee establishes a permanent residence in Washington. This provision also adds an additional expense of .03 percent to the premium.

What's Next for WA Cares?

The legislative changes came at a cost and the premium of .58 percent of wages was already insufficient to support the promised benefits. The above changes will increase the premium by at least another .06 percent of wages.

In addition, employees who move out of state will still lose all of the benefits that were paid for during their years of employment. Fixing the portability problem will double the cost of the coverage. The state plans to collect $1 billion a year from the employees by imposing a tax on employees' wages for coverage that is already projected not to be able to provide the promised benefit.

The cost issue needs to be addressed by the legislature in order to ensure that the promised benefit will actually be provided at a reasonable cost. In addition, it is likely that a state court lawsuit will be filed that will challenge WA Cares on the basis that the tax assessed on employees' wages is an unconstitutional income tax.

Employers should monitor the developments as we expect further updates and changes over the coming months and years.