Employer Reimbursement of Employee Health Insurance Premiums

Historically, many small employers haven’t directly offered group health insurance policies, but instead have reimbursed or directly paid some or all of the premium expense of policies purchased by their employees.  Beginning in 2014, the Affordable Care Act (ACA) presents at least two large problems with these arrangements.

1.     First, if more than one current employee is involved in the expense reimbursement plan, the government says the employer has established a group health plan.  The ACA prohibits group health plans from limiting the amount of medical benefits provided under the plan.  By design, reimbursement arrangements are limited to the cost of the premium.  Now, under the ACA, the reimbursement plan exposes the employer to potentially unlimited liability for employee medical costs.

2.     Second, if the employee purchases his or her policy on the health insurance marketplace or exchange, the employer’s reimbursement or payment of the premium is a violation of the ACA.  It does not matter whether or not the reimbursement or payment is treated as taxable wages or as a non-taxable, pre-tax reimbursement to the employee.  Plans that violate the ACA are subject to a $100 per day per employee penalty under IRC §4980D.

Another pitfall deals with more-than-2% S corporation shareholder employees.  IRS Notice 2008-1 permits the shareholder-employee to purchase an individual policy and to either be reimbursed by the S corporation or to have the S corporation directly pay the premium.  If the premium is included as income taxable wages on the W-2 (it isn’t subject to FICA or Medicare tax), the shareholder-employee may deduct the premium cost as self-employed health insurance.  However, this Notice 2008-1 pre-dates the ACA.  So if more than one employee is involved, the problems listed above apply.

What can be done to avoid these problems?  The employer should offer an ACA-compliant group health insurance policy for the employees instead of reimbursing the costs of individual policies.  The employer could also consider the small business health options program (SHOP), known as Avenue H in Utah.  Avenue H permits an employer to provide a sum of money for an employee to use to purchase a policy on that exchange.  Alternatively, the employer could simply increase their employees’ wages and let the employees purchase their own health insurance.  The wage increase should not refer to health insurance premiums.  As a small employer, there is no requirement to offer health insurance, so there is no penalty for increasing employee wages and letting them purchase their own insurance.  The downside, of course, is that increasing wages is not a tax efficient way for the employee to purchase insurance.  A better approach for tax purposes would be to use Avenue H which permits pre-tax money to be used to purchase health insurance.

For further guidance on these issues, see IRS Notice 2013-54 and a DOL FAQ on the subject.