Employers that wanted to help their employees pay for health care may have reimbursed employees for medical expenses or premiums to purchase individual health plans. Many of these good-intentioned employers were shocked to learn that, beginning in 2014, such arrangements may be subject to a $100 per-day, per-employee penalty. Small employers that are not required to provide group health coverage to their employees may not even realize that they also are subject to these penalties. Fortunately, the IRS recently issued guidance providing temporary penalty relief to small employers with certain types of these arrangements. The guidance also addresses lingering questions about the treatment of S corporation shareholder-employees and Medicare premium reimbursement arrangements.
Generally, a medical reimbursement plan is an employer-funded plan that reimburses employees for out-of-pocket health care costs up to a maximum dollar amount for a coverage period. Qualifying arrangements can be provided tax-free to employees under Internal Revenue Code Section 105 ("Section 105 plans"). Health Reimbursement Arrangements (HRAs) are Section 105 plans with a carryover feature. Another variation of a medical reimbursement plan is an employer payment plan where the employer reimburses an employee's substantiated premiums for individual health plans (or remits the premiums on the employee's behalf). For the remainder of this article, we will refer to all of these plans collectively as "medical reimbursement plans" unless otherwise noted.
Affordable Care Act Market Reforms
Among the market reform provisions of the Affordable Care Act ("ACA"), group health plans are prohibited from imposing an annual dollar limit on essential health benefits and are required to provide preventive health services (e.g., colonoscopies, mammograms) at no-cost to employees. These provisions were effective for health plan years beginning after 2013.
Excise Tax Penalty and Exceptions
In September of 2013, the IRS and the Department of Labor (DOL) issued guidance stating that medical reimbursement plans were group health plans for purposes of the ACA market reform provisions and, by their very nature, violate the no-annual-dollar-limit and required-preventive-health-services requirements. Plans that violate those market reform provisions are subject to an onerous $100 per-day, per-employee penalty (§4980D penalty). This means that the penalty for a plan in place for the entire year is $36,500 per employee covered by the medical reimbursement plan.
Certain types of medical reimbursement plans are exempt from the §4980D penalty, including:
- Ancillary benefit plans – plans that only cover ancillary benefits such as dental, vision, long-term care and disability coverage, which are not considered part of essential health benefits;
- Integrated Section 105 plans – plans that are coordinated with insurance coverage, so that the combined arrangement provides an ACA-compliant group health plan;
- Retiree-only plans – medical reimbursement plans covering only retired employees; and
- One-employee plans – medical reimbursement plans that only cover one employee (must comply with Section 105 nondiscrimination rules).
Prior guidance from the IRS and DOL implied that medical reimbursement plans potentially could avoid the §4980D penalty by simply treating the benefits as taxable compensation to the employees. Guidance from the DOL issued late last year clarified that whether the arrangement was pre-tax or post-tax is irrelevant; such arrangements still violate the ACA market reforms and are subject to the §4980D penalty.
IRS Provides Transition Relief for Small Businesses
In Notice 2015-17, the IRS reiterated previous guidance declaring that medical reimbursement plans violated the ACA market reforms applicable to group health plans (and thus are subject to the §4980D penalty). Notice 2015-17, however, provides transition relief from those penalties for employer payment plans ("EPPs") sponsored by small employers and certain other types of plans.
Under the relief provisions, the §4980D penalty will not be assessed against small employers with EPPs that pay, or reimburse employees, for individual health policy premiums or Medicare part B or D premiums in 2014 or from January 1 through June 30, 2015. "Small employer" for purposes of the transition relief is an employer that is not an applicable large employer for purposes of the employer shared responsibility payment mandate, i.e., generally not an employer with an average of at least 50 full-time employees (or equivalents) during the preceding calendar year. Small employers with EPPs are subject to the §4980D penalty beginning July 1, 2015.
Relief is Limited
The transition relief does not extend to stand-alone HRAs or other arrangements to reimburse employees for medical expenses other than insurance premiums. Also, applicable large employers for purposes of the employer shared responsibility payment mandate (generally 50 or more full-time employees) with EPPs are still subject to the §4980D penalty beginning January 1, 2014.
2-Percent S Corporation Shareholder-Employee Healthcare Arrangements
Generally, if an S corporation pays for or reimburses premiums for individual health insurance coverage covering a 2-percent shareholder-employee, the payment or reimbursement is included in the shareholder-employee's compensation (not subject to FICA or Medicare tax), but the 2-percent employee-shareholder may deduct 100 percent of the premiums "above-the-line" on his or her personal tax return (assuming all other criteria for deductibility have been satisfied). When the IRS and DOL declared that medical reimbursement plans violated ACA market reforms, taxpayers and tax practitioners were unclear on how those rules applied to these S corporation shareholder-employee arrangements.
The IRS and DOL have not concluded how such arrangements should be treated. Therefore, in Notice 2015-17, the IRS declared that the §4980D penalty will not be asserted on 2-percent S corporation shareholder-employee healthcare arrangements until further guidance is issued, and in any event not through the end of 2015. In addition, unless and until additional guidance provides otherwise, 2-percent shareholder-employees can continue to deduct health insurance premiums "above-the-line" on their personal tax returns (assuming all criteria for deductibility have been satisfied).
Note that the IRS Notice does not address partnerships with plans that reimburse partners for their individual health insurance coverage. Without further guidance, we must assume that these arrangements still violate the market reforms and are subject to the §4980D penalty.
Medicare Premium Reimbursement Plans
Notice 2015-17 also addresses plans that reimburse Medicare premiums. Generally, an employer arrangement to reimburse some or all of Medicare Part B or Part D premiums for employees constitutes an employer payment plan and, thus, is a group health plan subject to the ACA market reform provisions (assuming it covers two or more active employees). Medicare premium reimbursement plans, however, are subject to the same exceptions afforded regular medical reimbursement plans, i.e., such plans would not be subject to the §4980D penalty if they are provided to retirees only, or are coordinated with group insurance coverage so that the combined arrangement provides an ACA-compliant group health plan. Note, however, that Medicare reimbursement plans that are integrated with group health plans may violate Medicare's secondary payer rules.
What to Do with Arrangements that Violate the ACA Market Reforms
If your business still has an HRA, EPP or other medical reimbursement plan, you should take action as soon as possible. In most cases, you will need to terminate such arrangements, evaluate alternatives, and assess whether your business qualifies for transition relief. The IRS explicitly stated in Notice 2015-17 that if an employer increases an employee's compensation, but does not condition the payment of the additional compensation on the purchase of health coverage (or otherwise endorse a particular policy, form, or issuer of health insurance), the arrangement is not a group health plan that would potentially be subject to the §4980D penalty. Also, if in 2014 your business treated medical reimbursement plans as taxable compensation or subjected payments to 2-percent S corporation shareholder-employees to FICA and Medicare tax as a way to avoid the §4980D penalty, and you qualify for the small business relief, you may consider amending W-2s and payroll tax returns to treat those benefits as non-taxable or recover the FICA and Medicare tax withheld on 2-percent S corporation shareholders.
For more information on the limitations on medical reimbursement arrangements, and to discuss alternatives and solutions, contact
your local CBIZ MHM tax advisor.
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