Thursday, June 5, 2014

The IRS Will Begin Taxing Your Employer-Reimbursed Health Insurance

There was an article last week in the New York Times titled “IRS Bars Employers From Dumping Workers into Health Exchanges.” I scanned it quickly and made a note to return to the topic.

The IRS published Notice 2013-54 last year addressing, among other things, employer use of health reimbursement arrangements (HRAs). HRAs were popular for many years as a way to offer employees a tax-free fringe benefit. A common plan was employer reimbursement of qualifying medical expenses up to a limit (say $1,500 annually, for example). I used to be in one several years ago. Twice a year I would submit medical expenses for reimbursement. Shortly thereafter, I would receive a check, all without a nick to my W-2.

Then came ObamaCare.

There are questionable definitional rules under ObamaCare. For example, ObamaCare defines a coterie of health services to be “essential health benefits” (EHBs). You cannot have limits – either annual or lifetime – on EHBs. Why no limits?  It sounds great, like free ponies and summers off, but the government had to promise the insurance companies that it would subsidize them too if ObamaCare ran off the rails.

Think about the interaction of an HRA with the rule concerning EHBs. If an HRA is considered an EHB plan, then the plan will fail because there are annual limitations on the benefit. In our example, the limitation is $1,500, the maximum the plan would reimburse any one employee.

Notice 2013-54 considered HRAs to be just that, and now HRAs – with extremely limited carve-outs – are going the way of the dodo bird.

Let’s put a twist on the HRA example. Let’s say that you buy and your employer reimburses you for health insurance. Can that reimbursement be left off your W-2?

The New York Times was addressing that question.

Let’s go through the decision grid. I see three general ways an employer can approach health insurance:

(1)  The employer provides you with health insurance.
a.     In which case the rest of this discussion does not apply
(2)  The employer does not provide you with health insurance.
a.     Your employer may have issues depending on whether it has 50 employees or more.
                                                              i.     If no, there are no penalties.
                                                            ii.     If yes, your employer has penalties.
b.    You still have no insurance, though.
(3)  The employer does not provide you with health insurance but it does provide you with money to buy health insurance.
a.     Again, your employer may have penalties, depending on whether it has 50 or more employees.
b.    You have more money, but … do you have to pay tax on that money?

Since before Alaska and Hawaii became states, the answer to that question has been “No.”

With ObamaCare, the answer is now “Yes.”

The IRS has stated that any monies provided by your employer in scenario (3) above have to be included on your W-2. This means of course that you are paying taxes on it, and your employer is also paying taxes on it. You and your employer are unhappy with this. Retailers, homebuilders and car dealers are also unhappy with this, as you will have less after-tax money to spend with them. The only one who is happy with this is the government.

You know that there will be employers who are uninformed of these new rules - or informed but not care about any new rules. What will be their penalty for noncompliance?

That is what the IRS clarified last week. The penalty is $100 per day. Yes, that is $100 times 365 days = $36,500 per year. For each employee.

Let’s gain altitude and get some perspective on why the government is being so harsh. 

Remember that policies on the individual health exchanges are eligible for subsidy if one’s family income is less than 400% of the poverty line. The government does not want an employee to go the exchange and possibly receive a government subsidy at the same time that his/her employer is also providing a nontaxable employee benefit. That would be a double-dip.

You have to admit, it is a valid point.

It is also a valid point to question what the real government policy is here: for you to have health insurance or for the government to tax you? If the former, then the government could have reduced – or denied – health exchange subsidies to compensate for an employer reimbursement plan. If the latter, then the most recent IRS pronouncement makes perfect sense.

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