By Bill Bischoff
The Affordable Care Act (ACA), better known as Obamacare, established a number of so-called market reform restrictions on employer-provided group health plans, starting with plan years beginning in 2014. These restrictions generally apply to all employer-provided group health plans—including those furnished by small employers with fewer than 50 workers.
The penalty for running afoul of the market reform restrictions is $100 per-employee per-day, which can amount to $36,500 per employee over the course of a full year, up to $500,000 in total. In contrast, the penalty on businesses for failing to comply with the employer mandate is only $2,000 per year. According to the IRS, the penalty can be assessed on employers for simply offering plans that reimburse employees for premiums paid by them for individual health insurance policies. The penalty can also apply to direct employer payments of premiums for employees’ individual health policies. We will call such premium reimbursement/payment plans employer payment arrangements. This article explains what small employers need to know about the punitive $100 per-employee per-day penalty. But first, let’s cover some necessary background information
$100 per-employee per-day penalty generally applies to all employer payment arrangements
Employer payment arrangements have long been a popular way for small employers to help workers obtain health coverage without the hassle and expense of furnishing a full-fledged company health insurance plan. Under an employer payment arrangement, the employer reimburses participating employees for premiums paid for their individual health insurance policies or pays the premiums directly on behalf of participating employees.
Back in 2013, the IRS stated that before-tax employer payment arrangements are generally considered to be group health plans that are subject to the ACA market reform restrictions and the dreaded $100 per-employee per-day penalty. (Before-tax means tax-free to the employee.) With a few limited exceptions, such plans are considered by the Feds to fail to meet ACA requirements. However, many tax commentators had hoped and expected that after-tax employer payment arrangements would be exempted from the $100 per-employee per-day penalty. (After-tax treatment means the employer payments are treated as additional taxable wages paid to participating employees.) Those hopes were dashed this year when the IRS issued Notice 2015-17. According to the notice, an employer arrangement that reimburses or pays for employee individual health premiums is considered a group health plan that is subject to the $100 per-employee per-day penalty, whether the arrangement is treated by the employer as before-tax (tax-free to the employee) or after-tax (taxable to the employee).
Exception for one-employee arrangements
About the only good news here is that the $100 per-employee per-day penalty cannot be assessed on employer payment arrangements that have only one participating employee. Therefore, your business can still use such an arrangement to reimburse one employee for his or her individual health insurance premiums without triggering the disastrously expensive $100 per-employee per-day penalty.
Note: Under long-standing rules, employer payment arrangements generally must cover all full-time employees in order to avoid running afoul of IRS nondiscrimination provisions. However, the nondiscrimination rules allow employers to exclude workers who:,/span> (1) have less than three years of service, (2) have not attained age 25, or (3) meet the definition of part-time or seasonal employees. Therefore, an employer can potentially have more than one employee and still have a one-employee employer payment arrangement that is exempt from the $100 per-employee per-day penalty.
Temporary penalty exemption for many small businesses will expire on June 30
IRS Notice 2015-17 offered a temporary penalty exemption to small employers that reimburse or pay employee health premiums between Jan. 1, 2014 and June 30, 2015. A small employer is defined as one with fewer than 50 full-time employees (including full-time equivalent employees) during the prior year. However, unless something changes—and quickly—the relief for small employers will expire on June 30, 2015.
Temporary relief for s corporations lasts through year-end
Many S corporations have set up employer payment arrangements to cover individual health policy premiums for employees who also own more than 2% of the company stock (more-than-2% shareholder-employees). Under long-standing IRS rules, such reimbursements are treated as additional taxable wages that aren’t subject to Social Security or Medicare taxes. Qualifying more-than-2% shareholder employees can then deduct the premiums on their individual federal income tax returns under the provision for self-employed health insurance premiums. Unfortunately, such S corporation arrangements run afoul of the ACA market reform restrictions and can therefore trigger the punitive $100 per-employee per-day penalty.
Thankfully, IRS Notice 2015-17 exempts such plans from the $100 per-employee per-day penalty for health premiums reimbursed or paid by S corporations between Jan. 1, 2014 and Dec. 31, 2015. Bottom line: through year-end, there is no risk of incurring the penalty for S corporation employer payment arrangements that benefit only more-than-2% shareholder-employees. However, S corporation employer payment arrangements that benefit other employees are still exposed to the penalty.
The bipartisan Small Business Healthcare Relief Act, introduced last week in Congress would provide a remedy to this situation by enabling small businesses to continue to use health reimbursement arrangements, which allow employers to provide pre-tax dollars to employees to pay for medical care and services.