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.

New Tax On Self-Funded Health Plans Due By July 31

I knew that there was a new tax on self-insured medical plans. I was surprised that it reached health reimbursement arrangements (HRA), though.

I was surprised because it makes little sense, other than as a raw money grab. Next time perhaps the government will just select names at random from a phone book and require them to send money. I suggest they start with the District of Columbia phone book.

Have you heard of a health reimbursement arrangements? We are wading into alphabet soup-land, so let’s take a moment to compare and contrast an HRA with a health savings account (HSA).

 

If your employer is large enough, you may receive an annual letter laying out your health insurance options. Perhaps you can select from standard reimbursement, HMO, preferred provider or high-deductible health plans. That high-deductible plan likely is an HSA.

The concept of an HSA is simple: combine a high-deductible health policy with a medical IRA. If one incurs routine medical costs, one is reimbursed from the IRA. If one does not, then the IRA continues to compound and accumulate. The policy is there for big expenses. For a healthy family the medical IRA can add-up to tens of thousands of dollars.

A health reimbursement arrangement (HRA) is a different animal.   A key difference is that an HRA is all employer money. The HRA can reimburse employees for medical expenses, including vision, dental and chiropractic. It can reimburse on a first-dollar basis, a deductible-first basis, a sandwich basis and any other basis the plan advisor can dream up. It can have an annual cap … or not. Chances it will have an annual cap, as otherwise the employer borders on being financially reckless.

The employee doesn’t own this money, by the way. Should an employee quit, the money reverts to the employer. In truth, many if not most HRAs do not have any money at all. The medical bills are paid directly from company funds when presented for reimbursement. There may be an accounting somewhere that shows every employee and how many dollars are in his/her “account,” but this is for bookkeeping purposes only. The term for this is “notional,” and it means make-believe. Think unicorns, fairies and the New York Jets having a NFL-caliber quarterback.

ObamaCare (technically, The Affordable Care Act) is imposing a new fee on self-funded plans, which includes HRAs. It is coming up fast. If you have an HRA whose most current plan year ended after September 30, 2012 and before July 31, 2013 (that is, virtually every HRA), the HRA will have to pay a $1 fee per participant. Next year the fee goes to $2, and thereafter it goes to who-knows-what because some government bureaucrat will decide the amount.

The tax is due by the end of this month – July 31.

This tax will be reportable on Form 720, which may be a new filing for many employers.

It also has to be paid electronically. There is no attaching a check for this one.

I am a big fan of HRAs, as it allows companies to add to their employee benefits package without bankrupting themselves in the process. The HRA can cover deductibles, pay for braces or help with medical expenses that otherwise fall through the cracks left by the main insurance policy. HRAs have gotten more expensive, however, both by the per-participant fee as well as by the tax practitioner’s fee to prepare the return.