Prior to Dec. 31, 2013, some employers were able to provide health insurance by reimbursing their employees for their own individual (non-group) health insurance on a pre-tax or tax-free basis. This approach (also known as a defined contribution health plan) was a popular alternative and permissible prior to 2014 under a few different tactics. But since the beginning of 2014, these plans have been strictly prohibited.
Background
Prior to 2014, the Internal Revenue Service had long-established rules that permitted individual health insurance premium reimbursement by employers. The earliest such mention is IRS Revenue Ruling 61-146 stating that if an employer reimburses an employee’s substantiated premiums for non-employer sponsored hospital and medical insurance, the payments are excluded from the employee’s gross income under Code § 106. These arrangements were known as an employer payment plan, and applied if the employer paid the premiums directly to the insurance company or reimbursed the employee directly.
Using both health reimbursement arrangements (HRAs) and premium reimbursement accounts (PRAs), employers were permitted to reimburse their employees for non-group or individual health insurance premiums on a pre-tax (if employee was contributing to a PRA) or tax-free basis (if employer was reimbursing using either an HRA or a PRA). By relying on these two vehicles, employers could deduct any money they contributed to their employees’ health insurance premium cost as a business expense under IRC Section 152.
Finally, even before the ACA’s restrictions, employees could not use income that had been set aside on a pre-tax basis through a health flexible spending account to purchase individual health insurance premiums. As reflected in IRS Publication 969: “You cannot receive distributions from your FSA for… amounts paid for health insurance premiums.”
Regulatory action since adoption of ACA
When the ACA was adopted, it included various provisions that many saw as efforts to stop these reimbursement approaches beginning in 2014.
- ACA Section 1515: PRAs cannot pay for exchange/marketplace premiums. The ACA included specific language that prohibited PRAs from reimbursing employees for health insurance premiums purchased through the health insurance marketplace (see 26 USC § 125(f), as amended). This black-and-white statutory change was the clearest dead-end for one avenue to pre-tax or tax-free treatment of individual premiums.
- DOL FAQ 11, IRS Notices 2013-54, IRS Q&A 1: Standalone HRAs cannot be used for any individual premiums. The enforcement agencies have taken very clear action on pre-tax or tax-free treatment of individual health insurance premiums since 2012. They have specifically noted the difference between “integrated HRAs” and “standalone HRAs.”
An integrated HRA is one that’s integrated with a group health plan offered by an employer and which, under the terms of the HRA, is available only to employees who are covered by primary group health plan coverage that is provided by the employer and that meets the annual dollar limit prohibition. The guidance goes on to state that employer-sponsored HRAs cannot be integrated with individual market coverage
Any HRA that did not meet the definition of an integrated HRA is considered by the guidance to be a standalone HRA.
The guidance has focused on three broad prohibitions on standalone HRAs:
- Standalone health reimbursement arrangements violate the annual and lifetime limit benefit mandates and cannot be used after Jan. 1, 2014. Under the 11th release of FAQs by the U.S. Department of Labor, HRAs were prohibited by stating that these plans are considered group health plans and would violate the ACA’s prohibition on annual and lifetime limits.
- Employer payment plans must meet all ACA mandates. With the release of IRS Notice 2013-54, the IRS (and identical guidance issued by the DOL) stated very clearly that any standalone HRA must meet all mandates for group health plans (no annual or lifetime limits as well as provide no-cost preventive coverage for employees, and meet requirements related to minimum benefit value plans).
- Do not count as “offering coverage” for applicable large employers. HRAs and PRAs that are used to reimburse individual health insurance premiums are not considered as satisfying the large employer mandate to offer coverage, under IRS Guidance on Employer Health Arrangements issued on May 13, 2014.
In an apparent response to efforts by various vendors advocating that there were avenues to accomplish pre-tax reimbursement or payment plans, the Feds addressed one exception under the ACA:
The Departments understand that questions have arisen as to whether HRAs that are not integrated with a group health plan may be treated as a health FSA as defined in Code § 106(c)(2). Notice 2002-45, 2002-02 CB 93, states that, assuming that the maximum amount of reimbursement which is reasonably available to a participant under an HRA is not substantially in excess of the value of coverage under the HRA, an HRA is a health FSA as defined in Code § 106(c)(2). This statement was intended to clarify the rules limiting the payment of long-term care expenses by health FSAs. The Departments are also considering whether an HRA may be treated as a health FSA for purposes of the exclusion from the annual dollar limit prohibition. In any event, the treatment of an HRA as a health FSA that is not excepted benefits would not exempt the HRA from compliance with the other market reforms, including the preventive services requirements, which the HRA would fail to meet because the HRA would not be integrated with a group health plan. This analysis applies even if an HRA reimburses only premiums.
In the most recent posting, the IRS indicated that the U.S. Department of Health and Human Services would soon be issuing additional guidance on this issue.
Penalties for violating prohibition on employer pre-tax or tax-free reimbursement arrangements
There are three types of penalties that would apply for these pre-tax or tax-free reimbursement schemes:
- Violations of the ACA benefit mandate provisions (unlimited annual and lifetime limits, and preventive care mandates) would be subject to Section 4980(d) penalties of $100 per day per employee, which are capped at $500,000 per employer per year.
- Violations of the ACA applicable large employer mandate to offer coverage to their full-time employees would be subject to the 4980(a) excise tax penalty of $2,000 per full-time employee per year, or approximately $3,400 on a pre-tax basis.
- Under the May 13, 2014 guidance, the IRS noted that employers who offered standalone HRAs or PRAs in violation of their guidance and the related regulations would be subject to a $100 per day per person excise tax penalty, which equates to a pre-tax penalty of approximately $61,000 per employee per year for any such arrangements.
Each of these penalties are considered excise taxes, and therefore must be paid with pre-tax dollars and are not tax deductible business expenses for the employer.
Post-tax withholding of health insurance premiums is permitted
Under IRS Revenue Ruling 61-146, the IRS stated that in certain situations where the employee chooses either cash or an after-tax amount to be applied toward health coverage does not count as an employer payment plan. Individual employers may establish payroll practices of forwarding post-tax employee wages to a health insurance issuer at the direction of an employee without establishing a group health plan, if the standards of the DOL’s regulation at 29 C.F.R. §2510.3-1(j) are met.
This article was originally published by Benefits News:
