The End of Individual Health Policy Reimbursements
Originally published on February 10, 2015
Updated on October 31st, 2023
The Affordable Care Act (ACA) has established new “market reform provisions” that restrict an employer’s ability to reimburse employees for premiums paid on individual health insurance policies, also known as “employer payment arrangements.” Violation of these new reform provisions results in a penalty of $100 per-day, per-employee; or $36,500 per-employee, per-year.
“Employer Payment Arrangements” now Restricted under the Market Reform Provisions
Employer payment arrangements are popular with small employers who want to offer health insurance to their employees but are unable or unwilling to purchase a group health plan. Under these arrangements (for plan years beginning before 2014), the employer reimburses employees for premiums paid on their individual health insurance policies, or the employer sometimes pays the premium on behalf of the employee. As long as the employer (1) makes the reimbursement under a qualified medical reimbursement plan and (2) verifies that the reimbursement was spent only for insurance coverage, the premium reimbursement was excludable from the employee’s taxable income.
However, employers who currently participate in employment payment arrangements should discontinue. According to the IRS and Department of Labor (DOL), group health plans can’t be integrated with individual market policies to meet the new market reform provisions. As a result, according to the DOL, an employer that reimburses employees for individual policies on a pretax or after-tax basis has established a group health plan because the purpose of the arrangement is to provide medical care to its employees. Therefore, reimbursing employees for premiums paid on individual policies violates the market reform provisions, potentially subjecting the employer to the penalties referred to above.
The SHOP marketplace addresses many of the concerns of small employers. However, because the transition by eligible employers to SHOP Marketplace coverage or other alternatives will take time to implement, the IRS has provided transition relief for employers that are not applicable large employers (ALE). Under the guidelines issued by the IRS, penalties will not be asserted for any failure to satisfy the market reforms by employer payment plans that pay, or reimburse employees for individual health policy premiums or Medicare part B or Part D premiums (1) for 2014 for employers that are not ALEs for 2014, and (2) for January 1 through June 30, 2015 for employers that are not ALEs for 2015. After June 30, 2015 such employers may be liable for the $100 per day, per-employee; or $36,500 per-employee, per-year penalty.
An ALE generally is, with respect to a calendar year, an employer that employed an average of at least 50 full-time employees (including the full-time equivalents) on business days during the preceding calendar year. An employer may determine its status as an applicable large employer by reference to a period of at least three and no more than twelve consecutive calendar months, as chosen by the employer.
One-Employee Limited Exception:
The market reform provisions do not apply to group health plans that have only one participating employee. Therefore, it is still allowable to provide an employer payment arrangement that covers only one employee. The nondiscrimination rules require that essentially all full-time employees must participate in the plan.
S Corporation guidance:
The IRS is contemplating publication of additional guidance on the application of the market reforms to a 2-percent shareholder-employee healthcare arrangement. Until such guidance is issued, and in any event through the end of 2015, the penalties will not be asserted for any failure to satisfy the market reforms by a 2-percent shareholder-employee healthcare arrangement. This however, does not apply to reimbursements of individual health insurance coverage with respect to employees of an S corporation who are not 2-percent shareholders.
Although the market reform provisions do not apply to a group health plan with fewer than two participants, an S corporation cannot maintain more than one such arrangement for different employees (whether or not 2-percent shareholder employees). These arrangements will be treated as a single arrangement covering more than one employee and will not fall under the one-employee exception.
For example, if both a non-2-percent shareholder employee of an S corporation and a 2-percent shareholder employer of an S corporation are receiving reimbursements for individual premiums, the arrangement would be considered a group health plan for more than one current employee. However, if an employee is covered under a reimbursement arrangement with other-than-self-only coverage (such as family coverage) and another employee is covered by that same coverage as a spouse or dependent of the first employee, the arrangement would be considered to cover only the only employee.
What does this mean to you?
It is recommended that employers discontinue making payments under an employer payment arrangement, revoke any written documents, and classify any reimbursements made after 2013 as taxable wages.
There are acceptable alternatives for those employers who currently reimburse employees for individual healthcare policies. For example, employers may provide a tax-free fringe benefit by purchasing an ACA-approved employer-sponsored group health plan. Both the employer and the employee would incur additional Social Security (subject to limits) and Medicare taxes on the increased wages. The employer is able to deduct the additional wages. Employers with 50 or fewer employees can provide a group health plan through the Small Business Health Options Plan (SHOP) Marketplace and may qualify for a credit. A cafeteria plan can be set up for pretax funding of the employee portion of the premium. Employers with less than 50 employees can also drop health insurance coverage and not incur a penalty.
The employer may also increase the employee’s taxable wages to provide funds that the employee may use to pay for individual insurance policies. However, the employer cannot require that the funds be used to pay for health insurance. Although the wages are taxable to the employee, the employee may be able to deduct the premiums as an itemized deduction subject to the 10%-of-AGI floor (7.5% if age 65 or older).
Prior to the Affordable Care Act, the employer could pay for the individual health insurance policy of the employee and deduct it without the employee paying taxes on the amount. Certain employees without health insurance coverage by their employer may qualify for a subsidy on the exchange at www.healthcare.gov.
The Affordable Care Act significantly impacts both large and small companies. Do you have the proper team assembled to mitigate risk, manage health benefit costs, and comply with the major provisions of the Affordable Care Act? Contact the professionals at James Moore, CPAs to initiate a consultation for your company.
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