For plan years beginning after 2013, the Patient Protection and Affordable Care Act (PPACA) institutes so-called market reform provisions that place a whole host of new restrictions on group health plans. The excise tax for violating the market reform restrictions is a punitive $100-per-day, per-employee penalty; or $36,500 per employee, per year. With a limited exception, these new market reform provisions significantly restrict an employer’s ability to reimburse employees for premiums paid on individual health insurance policies, referred to as employer payment arrangements.

Employer payment plans
Under employer payment plans, the employer reimburses employees for premiums they pay on their individual health insurance policies (or the employer sometimes pays the premium on behalf of the employee). The premium reimbursement is excludable from the employee’s taxable income 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. These arrangements have long been popular with small employers who want to offer health insurance, but are unwilling or unable to purchase group health coverage.
Unfortunately, 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. Furthermore, 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 arrangement’s purpose 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 a $100-per-day, per-employee ($36,500-per-year, per-employee) excise tax.

Limited exception for one-employee plans.
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. Note, however, that nondiscrimination rules require that essentially all full-time employees must participate in the plan

The bottom line, is that while still technically allowed under the tax code, employer payment arrangements, other than arrangements covering only one employee, are no longer a viable alternative.

What should you do if you still have an employer payment plan?
First of all, don’t panic. You are not alone. The impact of the market reform provisions to these plans has come as a great surprise to many small business employers, not to mention the tax practitioner community, and we believe there is reasonable cause to keep the penalty from applying for earlier payments. However, it is important to discontinue making payments under the plan and rescind any written documents. Also, any reimbursements made after 2013 should be classified as taxable wages.

Acceptable alternatives
Because of the ACA market reform requirements, employers are basically precluded from subsidizing or reimbursing employees for individual health insurance policies if there is more than one employee participating in the plan. Employers can, however, continue to do 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 Small Business Health Options Plan (SHOP) Marketplace. A cafeteria plan can be set up for pretax 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 subject to the 10%-of-AGI limit (7.5% if age 65 or older).

Excise tax relief is available for certain small employers
Under the relief announced by IRS, an employer that is not an applicable large employer because it employs fewer than 50 full-time employees is eligible for relief from assessment of the Sec. 4980D excise tax. This relief applies through 2014 and, for those employers that do not meet the requirements in 2015, through June 30, 2015. This is intended to give small employers additional time to find health insurance coverage that complies with the new law. Eligible employers are also excused from filing Form 8928, Return of Certain Excise.

In a 2% shareholder-employee health care arrangement, the corporation typically purchases insurance for the shareholder, the premiums are included in the shareholder’s income, and he or she takes a deduction for them. Until further notice and at least until the end or 2015, these 2% shareholder plans will not be required to meet the market reform requirements. S corporations with these arrangements also will not be required to file Form 8928.

For more information, please contact Nimish Sanghavi.

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