Editor’s Note: More recent developments have occured since the publishing of this article. Learn more in “Churches Can Once Again Reimburse Employee Health Care Costs,” by attorney and CPA Richard R. Hammar.
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. The amounts paid by employers under such arrangements were nontaxable fringe benefits 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. 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.
Are these common and longstanding arrangements affected by the Affordable Care Act? Can employers continue to treat their payment of the health insurance premiums of employees under individual health insurance policies as a nontaxable fringe benefit? If they pay some or all of the premiums of their employees’ private health insurance, are its payments a nontaxable fringe benefit as in prior years? And what about churches that drop their health coverage in favor of what they assume will be a lower cost alternative of paying some or all of their employees’ premiums for insurance coverage purchased on a state exchange? Is this a nontaxable fringe benefit?
In late 2013, the IRS and Departments of Labor and Health and Human Services addressed these questions directly in IRS Notice 2013-54 (“Notice”). The Notice concludes that two of the Affordable Care Act’s “market reforms” apply to all “group health plans,” with a few exceptions, and it defines 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 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.
The Notice concludes that in most cases employer payment plans will fail to meet these market reforms and therefore 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.
Key point. A group health plan that violates one of the market reforms is subject to a penalty in the form of an excise tax of $100 per day per affected individual.
Are there any exceptions to these rules? 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. For 2014, 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 that many churches received in the past is only available for 2014 for plans purchased through the SHOP marketplace.
Churches that offer (1) health reimbursement arrangements (HRAs), including HRAs integrated with a group health plan; (2) group health 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; (3) health flexible spending arrangements (health FSAs); or (4) a Health Savings Account, should have them reviewed by legal counsel or a tax professional to ensure that they either comply with the Affordable Care Act’s market reforms, or qualify for an exception.
Read more about this development, including the effects of the IRS, Department of Labor, and Health and Human Services positions on HRAs, FSAs, and HSAs , in the upcoming May 2014 issue of Church Finance Today.