Insurance Roulette: Employer Payment Plans Advisory-Watch Out for Penalties

iRS Notice 2015-17, published Feb. 18, 2015, offers temporary relief from the excise tax penalty in Sec. 4980D, through June 30, 2015, for employers that reimburse employees for the cost of individual health insurance premiums. This notice also provides temporary relief, through 2015, for reimbursement arrangements involving the more than 2 percent S shareholders, and clarifies other issues relating to health reimbursement arrangements and the related excise tax penalty.

The Small Business FIcalthcarc Relief Act of 2015 (H.R. 2911 and S. 1697, July 7, 2015), would eliminate the need for relief by allowing small employers, free of penalties, to help employees purchase a health plan on the individual market, and establish taxfavored, stand-alone health reimbursement arrangements. The proposed legislation's fate is unpredictable.

Background

Several points must be understood to make sense of Notice 2015-17, as well as the desirability of legislative relief.

* Pursuant to the Affordable Care Act (ACA), employers with 50 or more full-time (including full-time equivalent) employees must provide health insurance or pay an excise tax (Sec. 4980H). The ACA does not require small employers to provide any health coverage to employees and does not penalize small employers for failing to do so. However, if the small employer does provide a group health plan to employees, then that plan must meet the ACA market reforms or the employer is subject to an excise tax of $ 100 per employee, per day (Sec. 4980D)-not counting the additional 5 percent penalty if the employer fails to file Form 8928 admitting liability for the Sec. 4980D tax.

* Historically many small employers, rather than providing a company group health insurance plan, have reimbursed all or a portion of the cost of their employees' individual insurance premiums. Such arrangements are income tax favored. Rev. Rui. 61-146 holds if certain, easily satisfied conditions are met, an employer reimbursement for non-employer sponsored health insurance is cxcludiblc from the employee's gross income under Sec. 106. The ACA does not change Rev. Rui. 61-146 or the Sec. 106 exclusion.

* The ACA change-the big problem for small employers-was first announced in Notice 2013-54 (Sept. 13, 2013). An arrangement in which an employer provides reimbursements for the purchase of major medical coverage in an individual market health insurance policy (inside or outside of the exchange), or directly pays the premium, is itself a group health plan provided by the employer, known as an employer payment plan. Furthermore, because the employer payment plan is deemed to be a group health plan, it's subject to the market reforms in the ACA, and worse, generally Colates the ACA market reforms "without regard to whether the employer treats the money as pre-tax or post-tax" (Notice 2015-17 Q&A 5). Employer payment plans violate the market reforms because they impose an annual limit and fail to provide cost-free preventive services. Even if the individual health insurance policy being reimbursed meets the aforementioned market reforms, it does not protect the employer payment plan because it cannot be "integrated" with the individual health insurance policy to satisfy the market reforms. Therefore, employer payment plans, though encouraged by favorable income tax treatment in Sec. 106, are discouraged by the ACA excise tax in Sec. 4980D.

* Any employer that fails to meet the market forms must file Form 8928, Return of Certain Excise Taxes Under Chapter 43 of the Internal Revenue Code, pay the excise tax and, if eligible, provide a reasonable cause excuse for a reduced penalty. Form 8928 must be filed by the due date for the employer's federal income tax return, but an extension can be obtained.

* If an S corp pays or reimburses the health insurance premiums for individual market coverage of a more than 2 percent shareholder, then that payment or reimbursement is income to the S shareholder. But the shareholder can deduct the amount of the premium, above AGI, if the requirements in Sec. 162(1) are satisfied. Notice 2008-1 provides that if health insurance premiums of 2 percent shareholders are not paid by the S corp, then the plan is not "established by the S corp" and the 2 percent shareholder is denied an above AGI deduction under Sec. 162(1) (Notice 2008-1). Therefore, a more than 2 percent shareholder who purchased individual health insurance with aftertax compensation-to allow the S corp to avoid the excise tax penalty in section 4980D-could not qualify for a deduction under Sec. 162(1). Such a shareholder would need to deduct the insurance premiums as an itemized deduction subject to the 10 percent floor for medical expenses (Notice 2008-1).

* Sec. 9831(a)(2) "provides that the market reforms do not apply to a group health plan that has fewer than two participants who are current employees on the first day of the plan year." So a reimbursement arrangement involving only one employee is not subject to the market reforms and thus not subject to the excise tax.

The Relief

The relief in Notice 2015-17 is from the excise tax (penally):

* Through June 30, 2015, no excise tax under Sec. 4980D will be imposed on a small employer's employer payment plan that reimburses employees for individual health insurance premiums or Medicare Part B or Part D. Employers eligible for the relief need not file Form 8928 "for the period for which the employer is eligible for the relief" (Q&A 1). According to the 1RS, the reason for the temporary relief is that the SHOP Marketplace is "still transitioning" and small employers needed more time to implement SHOP or other alternatives, such as eliminating the employer payment plan and paying higher compensation. The relevant time period for determining status as a small employer, thus eligibility for the transition relief, is:

* For employer payment plans in calendar year 2014, the employer is a small employer if it had fewer than 50 full-time (including full-time equivalent) employees for at least six consecutive months, as chosen by the employer, in 2013; and

* For employer payment plans through June 30, 2015, the employer is a small employer if it had fewer than 50 full-time (including full-time eqivalenl) employees for at least six consecutive months, as chosen by the employer, in 2014.

* Through the end of 2015 at the earliest, no excise tax penally under section 4980D will be imposed for "any failure to satisfy the market reforms by a 2 percent shareholder-employee health care arrangement." In other words, through 2015, employer payment plans can remain in place for more than 2 percent shareholder-employees. Also, absent additional guidance, no Form 8928 needs to be filed with respect to twopercent shareholders (see Q&A 2).

Clarifications in the 1RS Notice

Notice 2015-17 clarifies the single-employee exception from the market reforms in Sec. 9831(a)(2). An "arrangement covering only a single employee (whether or not a 2 percent shareholder-employee) generally is not subject to the market reforms whether or not such arrangement otherwise constitutes a group health plan."

Notice 2015-17 states "if an S corp maintains more than one such arrangement for different employees (whether or not 2 percent shareholders)," then "all such arrangements are treated as a single arrangement covering more than one employee so that the exception in Code Sec. 9831(a)(2) does not apply." 11 owe ver, if air employee has family coverage with a spouse or dependent who is also an employee, then "the arrangement would be considered to cover only one employee."

Notice 2015-17 clarifies that employer payment plans reimbursing Medicare Part B or D are subject to the market reforms, and cannot be integrated with Medicare, thus the plan generally violates the market reforms. An employer payment plan that has fewer than two employees who are current employees, such as a retiree only plan, is not subject to the market reforms. Note: An employee who has reached Social Security retirement age, but continues to work part-time is a current employee (not retired). Employer payment plans that reimburse Medicare Part B or D can be integrated with "with another group health plan offered by the employer for purposes of the annual dollar limit prohibition and the preventive services requirements if:

1. The employer offers a group health plan (other than the employer payment plan) to the employee that does not consist solely of excepted benefits and offers coverage providing minimum value;

2. The employee participating in the employer payment plan is actually enrolled in Medicare Parts A and B;

3. The employer payment plan is available only to employees who are enrolled in Medicare Part A and Part B or Part D; and

4. The employer payment plan is limited to reimbursement of Medicare Part B or Part D premiums and excepted benefits, including Medigap premiums."

Notice 2015-17 also explains health reimbursement arrangements (HRAs) with respect to TRICARE, the health care program for uniformed sendee members (the Military Health System, see Q&A 3).

The excise tax under Sec. 4980D, imposed against the employer, is independent of the employee's income lax consequences. The employee can exclude from income the reimbursements of employee premiums pursuant to an employer payment plan (per Rev. Rui. 61-146). Regardless, if the plan violates the market reforms, then the excise tax applies, whether or not the income is excluded by the employee (see Notice 2015-17, Q&A 5).

Increasing the employee's compensation is the simplest alternative for a small employer with a noncompliant employer payment plan. If the employer increases the employee's compensation, then that increase in compensation is not an employer payment plan; however, the payment of the additional compensation cannot be conditional on the purchase of health insurance "(or otherwise endorse, a particular policy, form, or issuer of health insurance)."

The Notice further clarifies that providing employees with premium tax credit information is "not endorsement of a particular policy, form, or issuer of health insurance." (Notice 2015-17, Q&A 4).

Not Mitigated in Notice 2015-17

The relief in Notice 2015-17 "does not extend to stand-alone HRAs or other arrangements to reimburse employees for medical expenses other than insurance premiums."

* The relief for more than 2 percent S shareholder-employees does not extend to other employees of the S corp. These arrangements are, however, eligible for the transitional relief through June 30, 2015, as long as the S corp is a small employer.

* Although not addressed in the Notice, it appears that relief similar to that for 2 percent S shareholders is needed for other individuals who are allowed to take a Sec. 162(1) deduction for individual market health insurance, such as partners in a partnership. Guidance is sorely needed on this subject.

Beginning July 1, 2015, employers may be liable for the excise tax if they fail to eliminate their noncompliant employer payment plans. Notice 2015-17, which is the fifth 1RS "issuance" on the subject (see footnote one of Notice 2015-17), makes it tougher for taxpayers to use ignorance of the law as a reasonable excuse for failing to lile Form 8928.

This is a significant issue that affects clients of many CPAs. It is challenging to explain to clients, but crucial to do so to lessen, and ideally avoid, a significant excise tax penalty.

BY GARY McBRIDE, CPA AND ANNETTE NELLEN

Gary McBride, CPA is a shareholder in Summit Accountancy Group, Inc. Annette Nellen Is a professor In and director of San Jose State University's graduate tax program. You can reach them at garyrmcb@yahoo.com and annette.nellen@sjsu.edu, respectively.