In the past, employers were allowed to either reimburse employees for the cost of individual health insurance policy premiums or pay the premiums directly on behalf of the employee. Provided the proper requirements were met, as required under the Internal Revenue Code, these benefits could be provided to the employee on a pre-tax basis. Due to the implementation of the market reform provisions of the Affordable Care Act (ACA), employer reimbursement of individual health insurance policies is severely restricted.
The ACA market reform provisions provide that employer health plans cannot impose annual dollar limits on certain health benefits and must provide preventative care services at no cost to the employee. Guidance issued from the IRS and the Department of Labor has ruled that employer reimbursements of individual health premiums do not meet these conditions because the reimbursement arrangements cannot be tested in conjunction with the coverage under the individual policy. As a result, employers using these arrangements may be subject to penalties of $100 per day/per employee, or in other words up to $36,500 per employee per year.
Originally, guidance from the IRS seemed to indicate that if the employer providing individual health care reimbursement included the reimbursements as taxable income in the employee’s W-2, they would not violate the market reforms. However, recent guidance issued in the form of Q&A on the Department of Labor website states that reimbursements paid to the employee either pre-tax or post-tax constitute an employer plan, and as such fail to comply with the ACA market reform provisions.
Limited Exception for One-Employer Plans
The market reform provisions do not apply to health plans, including medical reimbursement plans, that only have one employee. Therefore, it is still possible to provide an employer payment arrangement that only covers one employee. However, it is important to note that the tax law contains nondiscrimination rules which indicate that essentially all full-time employees must participate in the medical reimbursement, subject to limited exclusions for employees with less than 3 years of service or who are below the age of 25. Arrangements in violation of the non-discrimination rules would cause the benefits received by a key employee to become taxable.
Impact on S Corporation Shareholder Reimbursements
Frequently, S Corporation shareholders are reimbursed by their companies for the cost of premiums for individual coverage. In order for the individual policy premiums to be deductible as Self-Employed Health Insurance, an adjustment to gross income or “above the line” deduction, IRS rules require that the premiums must be reimbursed by the S Corporation or paid directly by the S Corporation on the shareholder’s behalf. Health insurance premiums for S Corporation shareholders must also be included in their W-2 as taxable wages, but are not subject to FICA employment tax.
Under the ACA, reimbursements for an S Corporation shareholder’s costs for individual health insurance are also deemed to be employer plans that do not meet the requirements of the market reform provisions and, as a result, employers using these arrangements may be subject to the $100 per day/per employee penalty discussed above
Options for Employers
Because of the ACA market reform requirements, employers are basically precluded from subsidizing or reimbursing employees for individual health insurance policies when there is more than one employee participating in the plan. Employers can, however, do the any of the following:
- Provide a tax-free fringe benefit by purchasing an ACA-approved employer-sponsored group health plan. Small employers with 50 or fewer employees can provide a group health plan through the SHOP Marketplace. A cafeteria plan can be set up for pre-tax funding of the employee portion of the premium.
- 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 insurance—it must be the employee’s decision to do so (or not). The employer can claim a deduction for the wages paid. The wages are taxable to the employee, but the employee can claim the premiums as an itemized deduction.
If you have questions or would like to discuss how your company can best address these changes in the law, please contact Thompson Greenspon so that one of our seasoned tax professionals can assist you.
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