United States

Affordable Care Act impact on certain health care plans

TAX ALERT  | 

In 2013, the IRS issued Notice 2013-54, which impacts tax-favored arrangements for paying employee health insurance premiums and medical expenses. The government reaffirmed this position in:

The affected arrangements include certain section 125 cafeteria plans, premium-only plans (POPs), premium reimbursement plans, health reimbursement arrangements (HRAs), medical expense reimbursement plans (MERPs or section 105 plans), and health flexible spending accounts (FSAs).

The IRS has determined that many of these arrangements will not meet the Affordable Care Act (ACA) requirements prohibiting annual dollar limits on benefits and employee cost-sharing on preventive services if the arrangements provide employer payments or reimbursements for individual health insurance or are not "integrated" with a group major medical plan. Consequently, employers may need to restructure or terminate these arrangements in order to avoid an excise tax.

Employers with plans or arrangements that fail to meet these ACA requirements may be liable for an excise tax of $100 per day per affected individual. The employer self-reports the tax in Part II of Form 8928, Return of Certain Excise Taxes Under Chapter 43 of the Internal Revenue Code, which has the same due date as the employer's federal tax return.

The IRS can waive part or all of the excise tax if the employer's failure to meet the ACA requirements is due to reasonable cause and not willful neglect. However, it is important for employers to strive to comply with the ACA rather than relying on the likelihood of the IRS waiving penalties.

The excise tax applies to for-profit and not-for-profit employers of all sizes. Large employers with at least 50 full-time employees (including full-time equivalents) can be subject to the excise tax starting in 2014. Small employers with fewer than 50 full-time employees (including full-time equivalents) are granted relief from the tax until July 1, 2015, but only for arrangements which pay or reimburse employee premiums. Small employers with arrangements which reimburse other employee health care expenses can be subject to the tax for 2014.

An employer's status as a large or small employer is determined taking into account its membership in a controlled or affiliated service group. Employers could be in a controlled or affiliated service group if they have common owners, provide services for each other or work together to provide services to third parties.

Affected arrangements

In general, employers will have exposure for the excise tax if they:

  • Pay or reimburse premiums for employees' individual health insurance policies or allow employees to use pre-tax salary reductions to pay for individual health insurance policies
  • Offer a health FSA but no group health plan, or have an employer contribution to the health FSA exceeding a certain dollar amount
  • Pay or reimburse employees' out-of-pocket medical expenses (such as deductibles and co-pays) that are associated with individual health insurance policies or are paid under any arrangement that is not "integrated" with a group medical plan

Individual health insurance. Individual health insurance is an insurance policy that an individual obtains to provide major medical coverage for the individual and family members. Many small employers do not offer a group major medical plan but instead pay or reimburse premiums on individual policies that employees obtain for themselves from insurance carriers. Some employers allow employees to pay for individual health insurance policies with pre-tax salary reductions through section 125 cafeteria plans or premium-only plans.

For plan years starting after 2013, employers have excise tax exposure if they pay or reimburse premiums for individual health insurance policies on either a pre-tax or post-tax basis. This includes individual health insurance purchased directly from insurance carriers or through the new healthcare Exchange/Marketplace. In addition, employers should not allow employees to buy this coverage with pre-tax salary reductions through their section 125 cafeteria plans or premium-only plans.

Employers can still pay or reimburse individual health policies for just one active employee and/or for retirees on a pre-tax or after-basis without triggering the excise tax. Furthermore, S corporations can pay or reimburse individual health insurance premiums for their more than 2 percent owners through Dec. 31, 2015, and until the IRS issues additional guidance.

Individual policies for dental, vision, disability, accident only (AD&D), long-term care, hospital indemnity, specific diseases (e.g., cancer), and certain other benefits generally may still be paid or reimbursed by an employer on a pre-tax or after-tax basis without triggering the excise tax, or be paid by employees with pre-tax salary reductions.

Medicare premium reimbursement arrangements. An employer can reimburse employees for their Medicare premiums without triggering the excise tax if the following requirements are met:

  • The employer offers to the employees a minimum value group health plan that does not consist solely of excepted benefits
  • The employees participating in the Medicare premium reimbursement arrangement are actually enrolled in Medicare Parts A and B
  • The Medicare premium reimbursement arrangement is only available to employees who are enrolled in Medicare Part A and Part B or Part D
  • The Medicare premium reimbursement arrangement only reimburses premiums for Medicare Part B or Part D and excepted benefits, such as Medigap coverage

However, employers should be aware of the Medicare secondary payer rules that could impose penalties on an employer for offering a financial or other incentive to active employees to encourage them to take Medicare rather than the employer's group health plan.

Health FSA. Many employers offer employees a health FSA through a section 125 cafeteria plan. The FSA allows employees to set aside pre-tax salary reductions to pay their out-of-pocket medical expenses. Employers, at their option, may contribute to the FSA.

To reduce excise tax exposure for plan years beginning after 2013, health FSAs generally must meet two requirements:

  • The employer must offer group health plan coverage (e.g., major medical) to employees.
  • The maximum benefit payable under the health FSA to any employee cannot exceed two times the employee's salary reduction election for the year, or, if greater, the employee's salary reduction election for the year plus $500. Health FSAs funded exclusively by employee salary reductions will automatically meet this maximum benefit test.

HRA/MERP. Some employers reimburse employees for their out-of-pocket medical costs through HRAs or other types of medical expense reimbursement plans (MERPs or section 105 plans). The employer may or may not offer a group health plan in addition to the HRA/MERP.

For plan years beginning after 2013, these reimbursement arrangements must be "integrated" with a group health plan to avoid the excise tax. Some exceptions apply, such as for an HRA/MERP that covers only retirees or one active employee, or that reimburses only dental or vision expenses. To be integrated, either the "minimum value required" standard or the "minimum value not required" standard must be met. However, integration does not require the HRA/MERP and the group health plan to share the same plan sponsor, share the same plan document, or file a single Form 5500.

Minimum value required. The following four conditions must be met in order for the minimum value required standard to be satisfied.

  • The employer offers to employees a group health plan (e.g., major medical) that provides minimum value. A group health plan will meet the minimum value requirement if it pays at least 60 percent of the total allowed benefits, with employees paying the remaining 40 percent through deductibles, co-pays, etc. The insurance company or other plan provider can determine if the plan meets this minimum value requirement.
  • The HRA/MERP is available only to employees who are enrolled in a group health plan that provides minimum value. The group health plan can be sponsored by the employer or another entity, such as the employer of an employee's spouse.
  • Each employee in the HRA/MERP is actually enrolled in a group health plan that provides minimum value, whether through the employer or another entity.
  • Under the terms of the HRA/MERP, an employee (or former employee) is permitted to permanently opt out of and waive future reimbursements at least annually, and upon termination of employment, either the remaining amounts in the HRA/MERP are forfeited or the employee is permitted to permanently opt out of and waive future reimbursements.

Minimum value not required. The following five conditions must be met in order for the minimum value not required standard to be satisfied.

  • The employer offers to employees a group health plan (e.g., major medical).
  • The HRA/MERP is available only to employees who are enrolled in a group health plan sponsored by the employer or another entity (such as the employer of an employee's spouse).
  • Each employee in the HRA/MERP is actually enrolled in a group health plan sponsored by the employer or another entity.
  • Under the terms of the HRA/MERP, an employee (or former employee) is permitted to permanently opt out of and waive future reimbursements at least annually, and upon termination of employment, either the remaining amounts in the HRA/MERP are forfeited or the employee is permitted to permanently opt out of and waive future reimbursements.
  • The HRA/MERP reimburses only one or more of the following: co-payments, co-insurance, deductibles and premiums under the group health plan, as well as medical care (as defined under code section 213(d)) that does not constitute essential health benefits. Essential health benefits includes items and services in 10 general categories:
    • Ambulatory patient services
    • Emergency services
    • Hospitalization
    • Maternity and newborn care
    • Mental health and substance use disorder services, including behavioral health treatment
    • Prescription drugs
    • Rehabilitative and habilitative services and devices
    • Laboratory services
    • Preventive and wellness services and chronic disease management
    • Pediatric services, including oral and vision care

TRICARE-related HRA. An employer that reimburses (or pays directly) some or all of the medical expenses of employees covered by TRICARE can avoid the excise tax if the following requirements are met:

  • The employer offers to the employees a minimum value group health plan that does not consist solely of excepted benefits
  • The employees participating in the HRA are actually enrolled in TRICARE
  • The HRA is only available to employees enrolled in TRICARE
  • The HRA is limited to reimbursement of cost sharing and excepted benefits, including TRICARE supplemental premiums

However, employers should be aware of laws that prohibit offering a financial or other incentive for TRICARE-eligible employees to decline employer-provided group health plan coverage.

Action plan

Employers should review their plan documents and plan operations to determine changes that may be needed. The rules are complex, and professional assistance is advised. In general, employers will need to amend or terminate any non-compliant arrangements to eliminate their excise tax exposure. Employers may wish to provide additional taxable income to employees to compensate them for the loss of these benefits.

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