Before December 31, 2013, certain employers had the ability to offer health insurance to their employees by reimbursing them for their personal health insurance plans, without the deduction of taxes. This method, known as a defined contribution health plan, was a widely chosen option and was allowed under various strategies prior to 2014. However, starting from the beginning of 2014, these plans have been completely forbidden.
Before 2014, the Internal Revenue Service had established rules that allowed employers to reimburse individual health insurance premiums. The first mention of this rule was in IRS Revenue Ruling 61-146, which stated that if an employer reimburses an employee’s confirmed premiums for hospital and medical insurance that is not sponsored by the employer, these payments would not count as part of the employee’s taxable income under Code § 106. These arrangements were referred to as employer payment plans, and they applied when the employer either directly paid the premiums to the insurance company or reimbursed the employee directly.
Employers had the option to utilize both health reimbursement arrangements (HRAs) and premium reimbursement accounts (PRAs) to provide tax-free reimbursements for non-group or individual health insurance premiums to their employees. If the employee contributed to a PRA, the reimbursement would be pre-tax, while if the employer used an HRA or PRA to reimburse, it would be tax-free. This allowed employers to deduct the amount they contributed towards their employees’ health insurance premiums as a business expense under IRC Section 152 by leveraging these two methods.
Prior to the ACA’s limitations, it was not possible for employees to utilize income that had been allocated pre-tax via a health flexible spending account in order to buy individual health insurance premiums. As stated in IRS Publication 969, individuals are unable to receive distributions from their FSA for payments made towards health insurance premiums.
Changes in regulation following the implementation of the Affordable Care Act
Many people viewed the provisions in the ACA that were adopted as attempts to halt these reimbursement approaches starting 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.”
A combined HRA is one that is combined with a health plan provided by an employer and is only accessible to employees who have coverage under the main employer-provided health plan and meets the restriction on annual dollar limits. The guidance continues to say that HRAs provided by employers cannot be combined with coverage from the individual market.
The guidance considers any HRA that does not meet the definition of an integrated HRA to be classified as a separate and independent HRA.
The guidance has been centered around three overarching restrictions on separate 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 what seems like a reaction to the attempts made by different sellers who argued that there existed ways to achieve pre-tax reimbursement or payment arrangements, the Federal government addressed one particular exemption under the Affordable Care Act (ACA):
The Departments acknowledge that there have been questions concerning whether HRAs that are not combined with a group health plan can be considered as a health FSA according to Code § 106(c)(2). Notice 2002-45, 2002-02 CB 93, states that as long as the amount of reimbursement available to a participant through an HRA is not significantly more than the value of coverage provided by the HRA, it can be considered a health FSA under Code § 106(c)(2). The objective of this statement was to clarify the regulations that restrict the payment of long-term care expenses through health FSAs. The Departments are also deliberating whether an HRA can be considered as a health FSA in order to avoid the restriction on annual dollar limits. Nevertheless, considering an HRA as a non-excepted benefit health FSA does not exempt it from complying with other market reforms, such as the requirements for preventive services, which the HRA cannot fulfill because it is not integrated with a group health plan. This analysis remains valid even if an HRA only reimburses premiums.
In the latest announcement, the IRS mentioned that further instructions on this matter would be provided by the U.S. Department of Health and Human Services in the near future.
Consequences for breaching the prohibition on employer arrangements for reimbursement that are pre-tax or tax-free.
There are three categories of penalties that would be applicable for these schemes of reimbursement that are either pre-tax or tax-exempt.
- 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.
Every one of these fines is regarded as excise levies, and hence, they have to be settled with funds that haven’t been taxed yet and cannot be classified as tax-deductible operational costs for the employer.
Health insurance premiums are allowed to be deducted after taxes are withheld.
According to the IRS Revenue Ruling 61-146, the IRS declared that in specific circumstances where the employee opts for either money or a post-tax sum to be used for health coverage, it will not be considered an employer payment plan. Individual employers can set up payroll procedures to send post-tax employee wages to a health insurance provider as instructed by the employee, without having to establish a group health plan, as long as they meet the specifications of the DOL’s regulation outlined in 29 C.F.R. §2510.3-1(j).
Smith holds the position of vice president at Ebenconcepts in the city of Fayetteville within the state of North Carolina. He can be reached at firstname.lastname@example.org.
The contents of this legal alert are intended for educational purposes solely and should not be construed as precise legal guidance.
Frequently Asked Questions
Can employers provide compensation to employees for the cost of insurance obtained through the ACA exchanges?
No, starting from 2014, employers are not allowed to provide compensation to employees for insurance costs obtained through the ACA exchanges.
What were the employer payment plans before the ACA limitations?
Before 2014, employers had the ability to either directly pay the premiums to the insurance company or reimburse the employee directly for individual health insurance premiums without them counting as part of the employee’s taxable income.
How did the Affordable Care Act change the regulations surrounding health reimbursement arrangements (HRAs)?
The ACA prohibited standalone HRAs from being used for individual premiums. Only integrated HRAs, those combined with an employer-provided health plan, are allowed. Standalone HRAs are considered to violate the ACA’s prohibitions on annual and lifetime limits.
Can health insurance premiums be deducted after taxes?
Yes, according to the IRS Revenue Ruling 61-146, health insurance premiums can be deducted after taxes are withheld under specific circumstances without establishing a group health plan.