AFFORDABLE CARE ACT: NOT SO AFFORDABLE FOR EMPLOYEE PREMIUM REIMBURSEMENT PLANS

For many years, penny-pinching small businesses resisted profit-draining health insurance plans. Instead, many chose to reimburse employees for their purchase of a personal health insurance policy. Historically, these premium reimbursements have not been treated as income to the employees, offering a low cost alternative to expensive health care plans. The Internal Revenue Code provided that if an employer reimbursed employee for substantiated premiums for hospital or medical insurance not otherwise provided by the employer, the payments were excluded from the employee’s gross income. It did not matter whether the employer paid the premiums directly to the insurance company or to the employee.

Along came the adoption of the Patient Protection and Affordable Care Act (ACA), which created certain market reforms. The ACA itself did not change the tax law, and in fact, an employer’s reimbursements for health insurance premiums are still excluded from an employee’s gross income. However, the adoption of the ACA created extensive penalties for such arrangements.

The ACA contains certain market reforms that are applicable to all group health plans, which were implemented to limit the stinginess of health insurers. Specifically at issue, any group health plan may not establish any limit on the dollar amount of benefits for any individual and must provide certain preventive services without imposing any cost-sharing requirements. The IRS and the Department of Labor (DOL) issued nearly identical guidance (IRS Notice 2013-54 and DOL Technical Release 2013-03) that defined the reimbursement arrangements as group health plans that are subject to the market reforms mentioned above. These publications further clarified that such arrangements cannot be integrated with individual policies to satisfy the market reforms. Governmental regulators concluded that employer reimbursements for health insurance policies imposed annual limits up to the cost of the individual market coverage purchased through the arrangement. In other words, the cost of the premium was a cap or a dollar limit on the benefits offered to the individuals in contradiction to the market reforms.

In November 2014, a new DOL FAQ clarified that the premium reimbursements were group health plans regardless of whether they were paid with pre-tax or post-tax dollars. As a result, beginning on January 1, 2014, employers violated the ACA if they reimbursed their employees for health insurance premiums. The excise tax imposed for violating the ACA is extensive. The fine is $100 per day, per employee, up to $36,500 per employee, per year.

While the tax law did not change, the insurance laws did. An employer can still reimburse employees for the premiums of their health plans and those premiums will still be tax free to the employee. Nevertheless, the unwary employer will be subject to these excise taxes imposed under the Code. A simple cost-benefit analysis will clearly show that the cost of the excise tax far exceeds the cost of health insurance premiums for each individual employee. Such fines would cripple most small businesses and force many to close their doors.

All is not lost however. Because the issue was not clearly understood by many small businesses, the IRS provided late-breaking relief on February 18, 2015. In IRS Notice 2015-17, the IRS provided for retroactive relief for market reform penalties in certain cases. Specifically, small employers (i.e., those with under 50 full-time employees and full-time equivalent employees) can enjoy relief from the ACA imposed excise taxes from January 1, 2014, through June 30, 2015. For those small businesses, the tax free exclusion for health insurance premium reimbursements can be claimed for all of 2014 and through June 30, 2015, without fear of facing the ACA excise taxes.

After June 30, 2015, however, employers can no longer offer direct-pay or reimbursement of employees’ health insurance premiums. To continue this practice will subject the small businesses to the daunting penalties of the ACA, at least under the current regulatory environment.

Small business employers have two choices to alleviate this situation beginning on July 1, 2015. The first, and probably the easiest, would be to provide an employer-sponsored health insurance plan that conforms to the mandates of the ACA. In the alternative, a small business employer may eliminate any group health insurance plan altogether and offer its employees the extra compensation. The extra compensation cannot have any requirement that the payments be used to purchase insurance coverage. By placing no strings on the extra compensation, the employer would not be creating a “group health plan” that would be subject to the ACA excise taxes. Unfortunately, however, the extra compensation would be taxable to the employees.

Small business employers who reimburse employees for health care premiums still have time to avoid paying the bankrupting penalties levied by the ACA, but time is running short, and the wise business owner will act promptly.

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