On December 13, 2016, President Obama signed H.R. 34, the 21st Century Cures Act, which contains legislation removing the $100 per-day, per-employee penalty for small employers who adopt a qualified small employer health reimbursement arrangement (QSEHRA). Small employers can take advantage of the new Affordable Care Act (ACA) rule beginning January 1, 2017, so leaders must quickly determine whether their organizations are eligible under the new legislation—and what steps they need to take if they wish to adopt the new arrangement.
Eligibility and Reimbursement Limits
The key features of the legislation, as contained in new tax code Section 9831(d), are as follows:
- An eligible small employer is one who employs fewer than 50 full-time employees and does not offer a group health plan to any of its employees.
- After the employee furnishes proof of coverage, the QSEHRA provides for the reimbursement of out-of-pocket medical expenses and insurance premiums incurred by the employee and, if specified in the plan, the employee’s family members.
- The plan is nondiscriminatory, although exclusions are allowed for employees with fewer than 90 days of service, those under age 25, and part-time and seasonal workers.
- All reimbursements are provided by the employer; no salary reduction contributions by employees are allowed. The reimbursements are deductible to the employer and tax-free to the employee.
- The total payments and reimbursements on behalf of any employee cannot exceed $4,950 per year—or $10,000 per year if the plan allows reimbursement for family members of the employee. These amounts are indexed to inflation in $50 increments using 2015 as the base year. The amounts for 2017 will be higher, but have not yet been announced. The employer may select any annual reimbursement amount within these limits.
- If the employee has purchased health insurance through an ACA exchange, any exchange subsidy—known as the Premium Tax Credit—will be reduced (but not below zero) to the extent of the permitted benefit under the QSEHRA. This prohibition, preventing dual subsidies from the employer and the ACA, is determined on a monthly basis.
In 2013, the IRS informed the employer community that provisions within the ACA created a barrier to employer health reimbursement arrangements. The ACA market reforms brought a penalty of $100 per day, per employee for employer-provided health benefits unless the benefits constituted full ACA-level health coverage. As a result, employers were prohibited from using Section 105 medical reimbursement plans that covered employee out-of-pocket medical costs, as well as Section 106 employer payment plans that reimbursed individual health insurance policy premiums. This IRS guidance, contained in Notice 2013-54, has very limited exceptions:
- An employer with only one employee is allowed to maintain these reimbursement arrangements. (The ACA rule affected groups of two or more.)
- Ancillary reimbursement plans, such as those covering only dental or vision costs, remain permissible.
- Employers providing a full ACA-level group health plan may also provide an out-of-pocket reimbursement arrangement for additional healthcare costs incurred by employees.
- Owners of pass-through entities (partners in partnerships and more-than-two percent S corporation shareholders) may have their health insurance premiums reimbursed by the entity per Notice 2015-17. These reimbursements are taxable to the individual owner, but that income is washed out by the 100-percent self-employed health insurance deduction within Form 1040.
Transition Relief Provisions
The new QSEHRAs apply to years beginning after 2016. The law allows adoption of these arrangements for plan years beginning immediately in 2017, even if the employer taxable year begins later in 2017 (i.e., an employer may offer an employee benefit on a self-designated plan year such as the calendar year, even though that may differ from the employer’s tax reporting year).
Though transition relief previously expired on June 30, 2015, the new legislation provides small employers transition relief from the $100 penalty if they reimbursed employee individual health premiums for years prior to 2017. The transition relief does not provide relief from penalties for prohibited reimbursement of out-of-pocket medical expenses.
Employee Notice and Reporting Requirements
A small employer adopting this arrangement must provide written advance notice to each eligible employee that includes:
- The amount of the employee’s permitted benefit for the year;
- A directive that the employee should provide the amount of the benefit arrangement to any health insurance exchange in which the employee participates; and
- A statement that the employee does not have tax-exempt reimbursements if the employee fails to maintain ACA-level health coverage for the year (i.e., these reimbursements become taxable to an employee who does not maintain ACA-level health insurance coverage).
In general, the employee notice is due 90 days before the beginning of each year. For coverage initiated in 2017, the employer may provide the employee notice by March 13, 2017, 90 days after enactment of the new law. In addition, the employer must report the total amount of permitted benefit for the year as memorandum information on the employee’s W-2.
A Tax-Efficient Change
Many small employers used these health reimbursement arrangements prior to the 2013 ACA pronouncement, and are familiar with the benefits of providing a portion of the employee compensation package in this manner. These arrangements are highly tax-efficient: the employer has a tax-deductible transfer to the employee that is free of payroll taxes, and the employee is tax-free on the reimbursement for both income tax and payroll tax purposes. The reimbursement arrangement covers costs the employee incurs annually on an after-tax basis, and is substituted for previously taxable wages, so both the employer and employee gain.
The employer-authorized reimbursement amount will directly reduce any ACA exchange subsidy, so employers should consider whether employees are using the exchange for their individual health policies before adopting a QSEHRA for 2017. Employees who have no health insurance must report any reimbursement amount as taxable income (although if the new reimbursement arrangement is a substitute for previously taxed compensation, there is effectively no detriment).
Employers should recognize that there may be only a short-term need to adhere to the new QSEHRA exception in Section 9831(d), as the ACA is clearly targeted for major modification by the new administration and Congress. If the market reform mandate and the related $100 per-day per-employee penalty are repealed, employers will again be able to use Section 105 and Section 106 reimbursement arrangements without the reimbursement limits and notification requirements that this special exception imposes. However, it is difficult to anticipate if and when this repeal would take place.
Small business employers interested in adopting a QSEHRA should engage with an employee benefits firm that provides the Section 105 plan documents and written notices, and assists with compliance. Benefits firms can be expected to provide amended paperwork if these arrangements become unnecessary in the future. Employers presently using an exception to the market reform penalty, such as the one employee exception or the partner/S shareholder exception, are free to continue doing so, as those health reimbursements are not subject to the limits of this new QSEHRA. iBi