Employers - Be Careful With Medical Reimbursement Plans

I am reading a notice from the Department of Labor titled “FAQs about Affordable Care Act Implementation (Part XXII)."

This will never make it as summer reading while on a beach.

And the DOL pretty much says what many practitioners concluded last year when the IRS issued Notice 2013-54, addressing employer reimbursement arrangements and individual health insurance policies acquired on an exchange.

COMMENT: “Exchange” and “marketplace” are the same.

The government does NOT like them.

Let’s clarify what we are talking about. There used to be a very common arrangement whereby an employer would pay your health insurance, reimburse your medical expenses, or a combination of the two, with no tax to you. These plans had several names, including health reimbursement plans or Section 105 plans. The practice had been around since before I was born.

Introduce ObamaCare. Say that someone goes on the exchange and buys an individual policy. Let’s take one more step and say that someone qualifies for a government subsidy on that individual policy.

Step One: You have someone getting money (in the form of the subsidy) from the government.

Say that person’s employer has a health reimbursement plan. The plan reimburses medical expenses, including insurance, up to some dollar amount – say $2,500.

Step Two: That person submits his/her government-subsidized Obamacare policy to the employer for reimbursement, up to $2,500.

To the extent that person’s share of the policy cost was less than $2,500, that person has broken even on the deal. To the extent that his/her share was $2,500 or more, his/her share of the cost would be $2,500 less.

Step Three: The government did not like this, did not like this at all. They huffed and they puffed and they issued Notice 2013-54, which pretty much indicated that the government was not going to allow a mixture of Obamacare individual health policies and employer reimbursement plans. Many practitioners were shocked. Heck, I myself had a similar plan at one time.

But there were a select few companies who continued marketing these things. Introduce some painful and lawyerly reading of the rules, and the companies declared that “their” plan would somehow pass muster with Notice 2013-54.

If there was any legitimate question, there is none now.

Let’s review Q&A 3:

Q: A vendor markets a product to employers claiming that employers can cancel their group policies, set up a Code section 105 reimbursement plan that works with health insurance brokers or agents to help employees select individual insurance policies, and allow eligible employees to access the premium tax credits for marketplace coverage. Is this permissible?

A: No. … the arrangements described in this Q3 are themselves group health plans and, therefore, employees participating in such arrangements are ineligible for premium tax credits….

Second, as explained in …, such arrangements are subject to the market reform provisions of the Affordable Care Act …. Such employer health care arrangements cannot be integrated with individual market policies to satisfy the market reforms, and, therefore, will violate …., which can trigger penalties such as excise taxes under section 4980D of the Code.

There are extremely limited exceptions, such as a one-person employer, but the broad broom has swept. The government is not going to allow a tax-free employer reimbursement for an individual policy acquired on an exchange.

So what if the employer included the reimbursement on the employee’s W-2? It would not be tax-free then, by definition. My previous understanding was that an employer could reimburse the individual policy, as long as the reimbursement was included on the employee’s W-2.

COMMENT: Another way to say it is that the government doesn’t care, as long as it gets its tax.

Let’s take a look at Q&A 1:

Q: My employer offers cash to reimburse the purchase of an individual market policy. Does this arrangement comply with the market reforms?

A: No. If the employer uses an arrangement that provides cash reimbursement for the purchase of an individual market policy, the employer’s payment arrangement is part of a plan, fund, or other arrangement established or maintained for the purpose of providing medical care to employees, without regard to whether the employer treats the money as pre-tax or post-tax to the employee.

Huh? Wait a minute here.

I interpret this to mean that an employer cannot have employees submit their insurance bills for reimbursement in lieu of other compensation. To phrase it differently, the employer must give the employee a raise (or bonus) and the employee must decide whether he/she wants to use the raise (or bonus) toward the insurance. The employee may decide to take the money and go on vacation; the employer cannot decide this for the employee.

By the way, notice that we have been speaking about individual health policies. The above discussion does not apply to group health policies acquired through SHOP, which is the exchange for businesses with less than 50 full-time employees. Those polices are group policies, not individual policies, and do not qualify for the ObamaCare subsidy. No subsidy, different rules.

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.