Since the Affordable Care Act (ACA)’s enactment, the IRS and the U.S. Department of Labor have delivered a rather unpleasant surprise to many, namely, that it now treats employers’ reimbursement or payment of employees’ individual health insurance premiums as taxable income to such employees (also known as health reimbursement arrangements or “HRAs”). This new rule, which essentially is an interpretation of “plan” under the ACA’s so-called market reforms, applies to small employers that are otherwise exempt under the ACA. The interpretation constitutes an about-face from the longstanding treatment of HRAs as a pre-tax employee benefit.
Transitional relief was granted when the IRS issued a notice in early 2015, providing that employers who provided such pre-tax benefit would not owe any penalties or be required to include such benefit as taxable income – at least through June 30, 2015. Such relief was extremely helpful (even though quite late), since the penalty for noncompliance is extreme: $100 fine per employee, per day (!).
At this point, no further tax relief for HRAs is on the horizon. Legislative rumblings of relief developed earlier this year but failed to produce any helpful result. Now that the U.S. Supreme Court upheld the ACA’s federal subsidy programs in its recent King v. Burwell ruling (and therefore its core elements), perhaps legislators will focus again on modifying such ACA aspects as this HRA issue. Instituting such relief would be both consistent with the fervent opposition of many politicians and greatly welcomed by many.
In the meantime, employers are essentially left with two choices with respect to reimbursement (or payment) of their employees’ individual health insurance premiums:
- Start complying with current legal requirements (e.g., by “grossing up" employees' wages so that they can pay such insurance costs with after-tax dollars, or ceasing such employee benefit entirely), as of July 2015 payroll; OR
- Face the possibility of severe tax penalties for non-compliance ($100 per day, per non-compliant employee reimbursement).
Please note that this newly enforceable tax regime applies for all employers that reimburse at least two employees’ health insurance premiums. A significant exception applies for one-participant-only reimbursement plans, which applies even if the employer has multiple employees.