The Internal Revenue Service has issued an official notice addressing the tax status of employer-paid medical insurance plans under the Affordable Care Act (“Obamacare”) and providing much-needed relief from the $100 per day per employee penalty that may be assessed against employers that continue to utilize these plans.
This article will explain the effects of the Affordable Care Act on these plans and fully address the most recent guidance and transitional relief provided by the IRS. This article provides vital information to any church that has paid for the cost of private health insurance for its employees.
background
Prior to the enactment of the Affordable Care Act, many employers provided health benefits for their employees by paying health insurers directly for the cost of private health insurance, or by reimbursing employees for the substantiated cost of insurance premiums. Such plans are called “employer payment plans” since the employer is paying an employee’s private health insurance. The amounts paid by employers under such arrangements was a nontaxable fringe benefit under section 106 of the tax code, which states that, with some exceptions, “gross income of an employee does not include employer-provided coverage under an accident or health plan.”
The IRS affirmed the tax-free status of these arrangements in a 1961 ruling in which it concluded that if an employer reimburses an employee’s substantiated premiums for non-employer sponsored medical insurance, the payments are excluded from the employee’s taxable income under section 106. IRS Revenue Ruling 61-146. The IRS added that this exclusion also applies if the employer pays the premiums directly to the insurance company.
Example. A church does not have a group health plan for its employees. Instead, employees purchase their own health insurance through private insurers, and the church reimburses employees who substantiate the amount of the health insurance premium they paid. Prior to the Affordable Care Act, the employer’s reimbursement of insurance premiums under such an arrangement was a nontaxable fringe benefit, subject to some conditions.
Example. The same facts as the previous example, except that the church paid the insurance companies directly for the cost of health insurance premiums on policies secured by their employees. Prior to the Affordable Care Act, the employer’s payment of insurance premiums under such an arrangement was a nontaxable fringe benefit, subject to some conditions.
IRS Notice 2013-54
In 2013, the IRS and Departments of Labor and Health and Human Services addressed the continuing availability of these plans under the Affordable Care Act. IRS Notice 2013-54. The Notice concluded that two of the Affordable Care Act’s “market reforms” apply to all “group health plans,” with a few exceptions, and it defined group health plans to include plans under which “an employer reimburses an employee for some or all of the premium expenses incurred for an individual health insurance policy … or arrangements under which the employer uses its funds to directly pay the premium for an individual health insurance policy covering the employee” (collectively, an “employer payment plan”).
The Affordable Care Act contains several “reforms” of the health insurance market (the “market reforms”) that apply to “group health plans” effective January 1, 2014. The market reforms include:
- The “annual dollar limit prohibition.” A group health plan may not establish any annual limit on the dollar amount of benefits for any individual.
- “The preventive services requirement.” Employer-sponsored group health plans must provide certain preventive services without imposing any cost-sharing requirements for these services on employees.
IRS Notice 2013-54 concludes that, in most cases, employer payment plans will fail to meet these market reforms and will be unlawful under the Affordable Care Act because they typically impose limits on benefits in violation of the annual dollar limit prohibition. The Notice explains:
A group health plan, such as an employer payment plan, that reimburses employees for an employee’s substantiated individual insurance policy premiums must satisfy the market reforms for group health plans. However, the employer payment plan will fail to comply with the annual dollar limit prohibition because (1) an employer payment plan is considered to impose an annual limit up to the cost of the individual market coverage purchased through the arrangement, and (2) an employer payment plan cannot be integrated with any individual health insurance policy purchased under the arrangement.
a hefty penalty
The Affordable Care Act added section 4980D to the tax code, which imposes a $100 per day per employee penalty on group plans that fail to meet the health insurance market reforms of the Act. Section 4980D(b)(3)(C) exempts “church plans” from this penalty. However, this does not mean that churches that continue to maintain employer payment plans are exempt from the $100 per day per affected employee penalty. This is so for two reasons.
First, and most importantly, the Affordable Care Act amends not only the federal tax code, but also ERISA and the Public Health Service Act (PHSA), and there are separate enforcement mechanisms under each statute. Churches are exempt from ERISA, but they are not exempt under the PHSA, which includes the identical penalties as section 4980D of the tax code for violations of the health insurance market reforms ($100 per day per affected employee). In short, while it is true that church plans are exempt from the $100 per day penalty under section 4980D, they are not exempt from the identical penalty under the PHSA.
Second, the IRS penalties under section 4980D are avoided only for entities meeting the technical definition of a “church plan.” Not all employer payment plans maintained by churches will satisfy this definition.
Employer Payment Plans
IRS Revenue Ruling 61-146 defines an employer payment plan as any plan under which “an employer reimburses an employee for some or all of the premium expenses incurred for an individual health insurance policy … or arrangements under which the employer uses its funds to directly pay the premium for an individual health insurance policy covering the employee.”
The bottom line is that the $100 per day excise tax penalty applies to any group plan that fails to incorporate all of the Affordable Care Act’s market reforms (a virtual impossibility), based not only on section 4980D of the tax code but on an identical provision in the PHSA.
The PHSA provides the following possible adjustments of the $100 per day penalty:
In the case of 1 or more failures with respect to an individual—(I) which are not corrected before the date on which the plan receives a notice from the Secretary of such violation; and (II) which occurred or continued during the period involved; the amount of penalty imposed … by reason of such failures with respect to such individual shall not be less than $2,500 [or $15,000 if “more than de minimis”] … .
No penalty shall be imposed … on any failure during any period for which it is established to the satisfaction of the Secretary that the person otherwise liable for such penalty did not know, and exercising reasonable diligence would not have known, that such failure existed … .
No penalty shall be imposed … on any failure if—(I) such failure was due to reasonable cause and not to willful neglect; and (II) such failure is corrected during the 30-day period beginning on the first date the person otherwise liable for such penalty knew, or exercising reasonable diligence would have known, that such failure existed.
In the case of failures which are due to reasonable cause and not to willful neglect, the penalty … for failures shall not exceed the amount equal to the lesser of—(I) 10 percent of the aggregate amount paid or incurred by the employer (or predecessor employer) during the preceding taxable year for group health plans; or (II) $500,000 … .
In the case of a failure which is due to reasonable cause and not to willful neglect, the Secretary may waive part or all of the penalty imposed by subparagraph (A) to the extent that the payment of such penalty would be excessive relative to the failure involved.
exceptions
Are there any exceptions to the $100 per day per employee penalty? Is there any way for churches to continue paying for employees’ health insurance through private insurers or state exchanges as a nontaxable fringe benefit? The Notice mentions three possibilities:
The market reforms do not apply to a group health plan that has fewer than two participants who are current employees on the first day of the plan year.
The market reforms do not apply to a group health plan with regard to “excepted benefits” which are defined to include disability income, dental and vision benefits, long-term care benefits, and certain health FSAs. As a result, these plans are not necessarily prohibited for failing to comply with the Affordable Care Act’s market reforms.
Another option that may allow some churches to continue to pay employee insurance premiums on a pre-tax basis is to participate in the “SHOP” (Small Business Health Options Program) marketplace. The SHOP marketplace makes it possible for small employers to provide qualified health plans to their employees. Some conditions apply. The SHOP marketplace is open to employers with 50 or fewer full-time-equivalent employees (FTEs). You may qualify for tax credits if you use SHOP. The small business health care tax credit is only available for 2014 and 2015 for plans purchased through the SHOP marketplace.
Key point. The notice acknowledges that “employers may establish payroll practices of forwarding post-tax employee wages to a health insurance issuer at the direction of an employee without establishing a group health plan if the standards of the Department of Labor regulation at 2510.3-1(j) are met.” These standards include: “(1) No contributions are made by an employer or employee organization; (2) Participation in the program is completely voluntary for employees or members; (3) The sole functions of the employer … with respect to the program are … to collect premiums through payroll deductions or dues checkoffs and to remit them to the insurer; and (4) The employer … receives no consideration in the form of cash or otherwise in connection with the program, other than reasonable compensation, excluding any profit, for administrative services actually rendered in connection with payroll deductions or dues checkoffs.”
treating employer payment plans as a taxable benefit
Many churches assume that they can continue to maintain their employer payment plan and avoid the $100 per day per employee penalty by treating their payments or reimbursements of employee health insurance as a taxable benefit. Until recently, many tax professionals shared this view. But, according to a Department of Labor document issued in November of 2014, this strategy does not avoid the penalty. The document (“FAQs about Affordable Care Act Implementation”) contains the following question and answer:
Q1: My employer offers employees cash to reimburse the purchase of an individual market policy. Does this arrangement comply with the market reforms?
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. Therefore, the arrangement is group health plan coverage within the meaning of Code section 9832(a), Employee Retirement Income Security Act (ERISA) section 733(a) and PHS Act section 2791(a), and is subject to the market reform provisions of the Affordable Care Act applicable to group health plans. Such employer health care arrangements cannot be integrated with individual market policies to satisfy the market reforms and, therefore, will violate PHS Act sections 2711 and 2713, among other provisions, which can trigger penalties such as excise taxes under section 4980D of the Code. Under the Departments’ prior published guidance, the cash arrangement fails to comply with the market reforms because the cash payment cannot be integrated with an individual market policy.
IRS Notice 2015-17
In February 2015, the IRS issued Notice 2015-17, which again addresses employer payment plans. This Notice affirms the tax status of employer payment plans, including the $100 per day per employee penalty, but provides much-needed “transitional relief” from this penalty for all of 2014 and the first six months of 2015 for employers with fewer than 50 employees. Here are the main points addressed in Notice 2015-17:
(1) status of employer payment plans
Notice 2015-17 begins by observing that it
reiterates the conclusion in previous guidance addressing employer payment plans, including Notice 2013-54, that employer payment plans are group health plans that will fail to comply with the market reforms that apply to group health plans under the Affordable Care Act (ACA). For this purpose, an employer payment plan as described in Notice 2013-54 refers to a group health plan under which an employer reimburses an employee for some or all of the premium expenses incurred for an individual health insurance policy or directly pays a premium for an individual health insurance policy covering the employee ….
Notice 2015-17 also affirms that “arrangements constituting employer payment plans fail to comply with the market reforms and may subject employers to the [$100 per day per employee excise tax].”
(2) transitional relief from the penalty
In announcing “transitional relief” from the $100 per day per employee penalty tax imposed on any employer maintaining an employer payment plan that fails to comply with the Affordable Care Act’s market reforms, Notice 2015-17 provides:
[The IRS and Department of Labor] understand that some employers that had been offering health coverage through an employer payment plan may need additional time to obtain group health coverage or adopt a suitable alternative.
The SHOP Marketplace addresses many of the concerns of small employers. However, because the market is still transitioning and the transition by eligible employers to SHOP Marketplace coverage or other alternatives will take time to implement, this guidance provides that the [$100 per day per employee penalty] will not be asserted for any failure to satisfy the market reforms by employer payment plans that pay, or reimburse employees for individual health policy premiums or Medicare part B or Part D premiums (1) for 2014 for employers that are not ALEs for 2014, and (2) for January 1 through June 30, 2015, for employers that are not ALEs for 2015. After June 30, 2015, such employers may be liable for the [$100 per day per employee penalty].
An ALE generally is, with respect to a calendar year, an employer that employed an average of at least 50 full-time employees (including full-time equivalent employees) on business days during the preceding calendar year. For determining whether an entity was an ALE for 2014 and for 2015, an employer may determine its status as an applicable large employer by reference to a period of at least six consecutive calendar months, as chosen by the employer, during the 2013 calendar year for determining ALE status for 2014 and during the 2014 calendar year for determining ALE status for 2015, as applicable (rather than by reference to the entire 2013 calendar year and the entire 2014 calendar year, as applicable).
Notice 2015-17 clarifies that employers eligible for the transitional relief and that have employer payment plans “are not required to file IRS Form 8928 (regarding failures to satisfy requirements for group health plans, including the market reforms) solely as a result of having such arrangements for the period for which the employer is eligible for the relief.”
Key point. Notice 2015-17 clarifies that “this relief does not extend to stand-alone HRAs or other arrangements to reimburse employees for medical expenses other than insurance premiums.”
(3) increasing employee compensation to assist with payment of medical insurance premiums
If an employer increases an employee’s compensation, but does not condition the payment of the additional compensation on the purchase of health coverage (or otherwise endorse a particular policy, form, or issuer of health insurance), is this arrangement an employer payment plan?
Notice 2015-17 answers this question as follows:
No. As described in Notice 2013-54, an employer payment plan is a group health plan under which an employer reimburses an employee for some or all of the premium expenses incurred for an individual health insurance policy or directly pays a premium for an individual health insurance policy covering the employee … . The arrangement described [above] does not meet that description. In addition, because the arrangement generally will not constitute a group health plan, it is not subject to the market reforms.
Similarly, Notice 2013-54 provides that an employer payment plan “does not include an employer-sponsored arrangement under which an employee may choose either cash or an after-tax amount to be applied toward health coverage. Individual employers may establish payroll practices of forwarding post-tax employee wages to a health insurance issuer at the direction of an employee without establishing a group health plan, if the standards of the DOL’s regulation 2510.3-1(j) are met.” These standards include: “(1) No contributions are made by an employer or employee organization; (2) Participation in the program is completely voluntary for employees or members; (3) The sole functions of the employer … with respect to the program are … to collect premiums through payroll deductions or dues checkoffs and to remit them to the insurer; and (4) The employer … receives no consideration in the form of cash or otherwise in connection with the program, other than reasonable compensation, excluding any profit, for administrative services actually rendered in connection with payroll deductions or dues checkoffs.”
(4) treating an employer payment plan as taxable compensation
May the reimbursements or payments under an employer payment plan be provided on an after-tax basis and, if so, will this cause the arrangement not to be a group health plan (and accordingly not to be subject to the market reforms and the $100 per day per employee penalty)?
Notice 2015-17 answers this question as follows:
No. IRS Revenue Ruling 61-146 (1961) holds that under certain conditions, if an employer reimburses an employee’s substantiated premiums for non-employer sponsored hospital and medical insurance, the payments are excluded from the employee’s gross income under Code section 106. This exclusion also applies if the employer pays the premiums directly to the insurance company. The holding in Revenue Ruling 61-146 continues to apply, meaning only that payments under arrangements that meet the conditions set forth in Revenue Ruling 61-146 are excludable from the employee’s gross income under Code section 106 (regardless of whether the employer includes the payments as wage payments on the Form W-2).
However, Revenue Ruling 61-146 does not address the application of the market reforms and should not be read as containing any implication regarding the application of the market reforms. As explained in Notice 2013-54, an arrangement under which an employer provides reimbursements or payments that are dedicated to providing medical care, such as cash reimbursements for the purchase of an individual market policy, is itself a group health plan. Accordingly, the arrangement is subject to the market reform provisions of the Affordable Care Act applicable to group health plans without regard to whether the employer treats the money as pre-tax or post-tax to the employee. Such employer health care arrangements cannot be integrated with individual market policies to satisfy the market reforms.
(5) Medicare premium reimbursement arrangements
If an employer offers to reimburse Medicare premiums for its active employees, does this arrangement create an employer payment plan under Notice 2013-54? Notice 2015-17 answers this question as follows:
An arrangement under which an employer reimburses (or pays directly) some or all of Medicare Part B or Part D premiums for employees constitutes an employer payment plan, as described in Notice 2013-54, and if such an arrangement covers two or more active employees, [it] is a group health plan subject to the market reforms. An employer payment plan may not be integrated with Medicare coverage to satisfy the market reforms because Medicare coverage is not a group health plan.
However, an employer payment plan that pays for or reimburses Medicare Part B or Part D premiums is integrated with another group health plan offered by the employer for purposes of the [market reforms] if (1) the employer offers a group health plan (other than the employer payment plan) to the employee that does not consist solely of excepted benefits and offers coverage providing minimum value; (2) the employee participating in the employer payment plan is actually enrolled in Medicare Parts A and B; (3) the employer payment plan is available only to employees who are enrolled in Medicare Part A and Part B or Part D; and (4) the employer payment plan is limited to reimbursement of Medicare Part B or Part D premiums and excepted benefits, including Medigap premiums.
Ten Conclusions
Churches that have used an employer payment plan in the past, or that are using one now, should bear in mind the following ten points:
1. Such plans trigger a significant penalty of $100 per day per affected employee. This penalty applies to any employer payment plan adopted since January 1, 2014.
2. Employers with fewer than 50 employees since January 1, 2014, are eligible for transitional relief announced by the IRS in Notice 2015-17. This means that they will not incur the $100 per day per employee penalty for operating an employer payment plan at any time from January 2014 through the first half of 2015. However, the penalty will be imposed thereafter, so you should discontinue any existing employer payment plan and consider other means of providing health coverage for your employees. One way that was approved by the IRS in Notice 2015-17 is to implement a plan that increases an employee’s compensation, “but does not condition the payment of the additional compensation on the purchase of health coverage (or otherwise endorse a particular policy, form, or issuer of health insurance).”
3. “Large employers” with 50 or more employees (as defined above) should terminate their employer payment plan immediately since they are not eligible for transition relief from the $100 per day per affected employee penalty. It is imperative that these employers consult with a tax professional to minimize or avoid the risk of triggering the penalty.
4. The Affordable Care Act imposed an additional penalty on “large employers” that did not offer a group health plan to employees by January 1, 2015. This deadline was later postponed to January 1, 2016, for employers with 50 to 99 employees. In anticipation of this requirement, many, if not most, larger employers already have implemented a group health plan compatible with the Affordable Care Act’s market reforms. This will minimize, and in some cases avoid, the $100 per day per employee penalty for these employers.
5. In the past, some employers thought that they could avoid the $100 per day per employee penalty by treating their payment or reimbursement of employee health insurance as a taxable fringe benefit reported on Forms W-2 and 941. Employees of churches that followed this practice in 2014 should discuss with a tax professional the possibility of claiming a tax refund. The reasoning is that employer payment plans technically remain a nontaxable fringe benefit. Revenue Ruling 61-146 and section 106 of the federal tax code (explained above) were not repealed or revoked by the Affordable Care Act. Few, if any, employers will continue providing this benefit to employees because it will trigger the $100 per day per employee penalty. But, employers with fewer than 50 employees are eligible for transitional relief from this penalty for 2014 and the first half of 2015. This means that employees whose W-2 reported the amount of their employer’s payment or reimbursement of personal health insurance may be entitled to a refund. Check with your tax professional for further details.
6. IRS Notice 2015-17 affirms that the $100 per day per employee penalty can be avoided if an employer simply “increases an employee’s compensation, but does not condition the payment of the additional compensation on the purchase of health coverage (or otherwise endorse a particular policy, form, or issuer of health insurance).” Similarly, Notice 2013-54 provides that an employer payment plan “does not include an employer-sponsored arrangement under which an employee may choose either cash or an after-tax amount to be applied toward health coverage. Individual employers may establish payroll practices of forwarding post-tax employee wages to a health insurance issuer at the direction of an employee without establishing a group health plan, if the standards of the DOL’s (Department of Labor’s) regulation 2510.3-1(j) are met.” These standards are summarized above.
7. Notice 2015-17 clarifies that employers eligible for the transitional relief and that have employer payment plans are not required to file IRS Form 8928 to qualify for the relief. Form 8928 is the form used by employers to report the $100 per day per employee penalty tax for failing to comply with the market reforms under the Affordable Care Act.
8. An arrangement under which an employer reimburses (or pays directly) some or all of Medicare Part B or Part D premiums for employees constitutes an employer payment plan, as described in Notice 2013-54, and if such an arrangement covers two or more active employees, is a group health plan subject to the market reforms. An employer payment plan may not be integrated with Medicare coverage to satisfy the market reforms because Medicare coverage is not a group health plan.
9. The $100 per day per employee penalty applies to all employers, including, but not limited to, religious employers. Employer payment plans have been popular not just among churches, but also among small for-profit employers. As awareness of this penalty builds, Congress has come under mounting pressure to provide permanent relief. Several employer groups and trade associations are lobbying Congress for change, including the National Association for the Self-Employed. Some members of Congress are taking notice. Senator Charles Grassley (R-IA) recently observed:
I’ve heard from several Iowa small business owners who feared they could be subject to thousands of dollars in penalties simply because they helped their employees pay for health insurance in 2014. For these and other affected businesses, the penalty relief is welcome news, but ultimately it only delays the inevitable. Small businesses are still prohibited from reimbursing their employees to purchase health insurance. It’s just a matter of when they have to come into compliance with the law. Small businesses and their employees still will be hurt going forward. Congress has to fix this problem.
Any developments will be reported in future issues of this newsletter, and posted to our website, ChurchLawAndTax.com.
10. The principal author of Notice 2015-17 is Shad Fagerland of the Office of Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this notice, you may contact Fagerland at (202) 317-5500 (Note: not a toll-free call). Additional questions regarding this information may be directed to the IRS at (202) 317-6846 (Note: also not a toll-free call).
