New Guidance Clarifies Reimbursement of Employee Health Costs
A recent Department of Labor (DOL) news release clarifies the restrictions on employer-provided reimbursements of health care costs under the Affordable Care Act. The release says these reimbursement arrangements, even if reported as taxable payroll to the employee, represent a violation of the ACA market reform rules. This potentially subjects the employer to a penalty as high as $100 per day per employee. This guidance is effective for health plan years beginning on or after January 1, 2014.
As a practical matter, it is small employers using reimbursement arrangements that face this risk. Larger employers with 100 or more employees are subject to a mandate to provide group health coverage to employees beginning with their 2015 health plan year, and those with 50 or more employees face this mandate beginning in 2016.
There are three arrangements that remain exempt from these market reform rules:
- A one-employee health plan
- An employer-provided group insurance plan, whether furnished alone or accompanied by an integrated medical reimbursement plan
- Reimbursement plans that cover only ancillary benefits such as dental, vision, or long-term care premiums.
Prior to this latest DOL guidance, it was generally understood by tax advisors that including reimbursed premiums and other medical reimbursement arrangements in employee taxable wages would avoid the ACA penalties; this was based on IRS “Q and A” guidance issued in May of 2014. Because of this earlier status, there should be a “reasonable cause” defense for any prior payments within 2014, assuming corrective action is taken promptly after receipt of this notification. Reasonable cause applies if the employer corrects the failure during the 30 day period from when the employer knew of the DOL requirements.
Accordingly, unless you meet one of the exceptions identified above, employers with health reimbursement arrangements should immediately take three actions:
- Discontinue any payments or reimbursements of employee individual health insurance policy premiums, as well as any reimbursements under employer-provided medical reimbursement plans.
- Rescind any written plan documents, retroactive to the first day within 2014 for which the plan was effective.
- Recharacterize any amounts paid to employees for these reimbursements as taxable compensation.
Owners of pass-through entities (specifically, partners in partnerships and those who own, directly or through family attribution, more than 2 percent of the stock of an S corporation) may face a unique problem under the latest Department of Labor (DOL) guidance regarding the ACA market reform penalties.
The issue relates to the special rule allowing partners and more-than-2 percent shareholders to claim the full deduction for their medical insurance on page one of their Form 1040. Depending on who owns and provides the health insurance, there may be a conflict with the new ACA market reform guidance.
Entity provides health insurance
If the partnership or S corporation carries a group health insurance policy and that policy includes a partner or a shareholder, the new market reform restrictions should not present an issue. A business that provides an ACA-compliant health insurance policy to its workers should meet the ACA market reforms and no special action is required. Accordingly, as in the past, a partnership reports the partner’s portion of the health insurance premium as a guaranteed payment on that partner’s Schedule K-1. In the case of an S corporation, the shareholder’s portion of the premium is added to box 1 of that individual’s Form W-2 as wages subject to income tax, but the amount is not added to boxes 3 and 5 of the Form W-2 as wages for Social Security tax purposes. This reporting treatment by the entity as either a guaranteed payment or addition to the W-2 is necessary for the owner to claim the health insurance deduction on page 1 of the Form 1040.
One employee plan exception
If the partner or S corporation shareholder is the only individual within the business that participates in the health insurance plan, the new ACA market reform restrictions are not applicable. Accordingly, the same guidance for reporting applies as discussed in the previous paragraph (i.e., guaranteed payment treatment on Schedule K-1 for the partner or Form W-2 box 1 income tax reporting to the S corporation shareholder). This result applies regardless of whether the health insurance is provided by the business directly, or is an individually-owned policy with the premium reimbursed by the entity.
If the one employee exception is used for an owner, it is critical that the health insurance is provided as a compensatory employee benefit rather than as a shareholder/owner benefit. The health insurance plan should be provided by the corporation as part of an employment agreement for that particular individual.
Individually-owned health insurance policy
The conflicting tax guidance from the IRS and DOL arises with respect to an individually-owned policy where the one employee exception is not available. The long standing IRS guidance requires the business entity to reimburse the partner or S shareholder for the individual’s health insurance premium costs, in order to allow the health insurance deduction on the owner’s Form 1040. However, the recent DOL guidance on the market reform rules indicates that this could expose the entity to the $100 per day per individual market reform penalty.
The market reform penalty contains a reasonable cause exception which reduces the onerous $100 per day penalty to a lower amount (10% of the amount paid or reimbursed by the employer for the health plan in the prior taxable year). In addition, the IRS may reduce or waive the penalty where reasonable cause exists.
In view of these reasonable cause exceptions and the conflicting authorities, we recommend following the existing IRS guidance that requires reimbursement of the individual owner’s health insurance premium. This preserves the health insurance deduction in the owner’s Form 1040. However, in the case of an S corporation shareholder, the Form W-2 reporting should include subjecting the reimbursement to FICA payroll taxes (i.e., including the reimbursement as income in boxes 3 and 5 of Form W-2). This is necessary to minimize the assertion that there is an employer-provided health plan.
Our firm has joined with others in the CPA community requesting the IRS address to clarify the inconsistent guidance that exists with respect to partner and S corporation owners and their health insurance premiums.
Chris Hesse, CPA is a principal in the accounting and advisory firm of CliftonLarsonAllen LLP. Chris is a former Grant County Farm Bureau president and former member of the Washington Farm Bureau Service Company board. He provides Federal tax advice from firm headquarters in Minneapolis. His son and other members of his family farm in Grant County west of Moses Lake.