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Impacts of financial decisions
IRS Relief for Small Employer Health Premium Reimbursements
Small employers that have reimbursed or directly paid employee individual health insurance policy premiums may benefit from retroactive IRS relief that is now available. But this temporary relief from the market reform penalty only applies to reimbursements of health insurance premiums. It does not relieve the penalty for employer-provided medical reimbursement plans or health reimbursement arrangements that cover other out-of-pocket medical expenses of employees.
Small employers and some S corporations may need to amend payroll returns that have already been submitted for the 2014 tax year.
Background on tax-free premium reimbursements
Small employers have commonly used reimbursement arrangements to help employees with their individual health insurance premiums and out-of-pocket health care costs. Premium reimbursements are tax-free to the employee under Section 106 of the tax code. Medical expense reimbursement plans are similarly tax-free under Section 105.
Neither of these tax-free fringe benefits was altered by the Affordable Care Act. Instead, a separate set of market reforms imposed an expensive $100-per-day-per-employee penalty on employers that maintained these reimbursement arrangements, effective for health plan years beginning in 2014. We have previously reported on IRS directives that required these reimbursement arrangements to be terminated and any reimbursements converted to compensation, if the employer was to avoid the market reform penalty. For further background see New Restrictions on Employer-Provided Medical Expense Reimbursement Plans from November 2013, and New Guidance Clarifies Reimbursement of Health Costs from December 2014.
Late-breaking IRS relief
On February 18, 2015, the IRS issued Notice 2015-17, providing retroactive relief from the $100-per-day-per-employee market reform penalty for two situations:
- Small employers (under 50 full-time and full-time equivalent employees) who directly pay or reimburse individual health insurance policy premiums of employees from January 1, 2014 through June 30, 2015.
- S corporations that reimburse or directly pay individual health insurance policy premiums for over 2 percent shareholder-employees from January 1, 2014 through December 31, 2015.
Action required: Possibly amend payroll reports
While this retroactive relief is welcome, it comes late and is sure to cause frustration among employers and tax professionals.
Based on IRS guidance in 2013, small employers have been told that employer premium reimbursements were a violation of the market reforms. Late in 2014, the IRS and the Department of Labor indicated that premium reimbursements, even if reported as taxable compensation, violated the market reforms and exposed the employer to the penalty.
As a result, small employers issuing 2014 W-2 forms in January 2015 reported these reimbursements as taxable, both for income taxes and Social Security taxes. But now, a few weeks after payroll taxes are paid and reports issued, the $100 penalty has been retroactively removed.
More-than-2-percent S corporation shareholders
If your S corporation reimbursed the health insurance premiums of shareholder-employees owning more than 2 percent of the stock, the S corporation should have included the premium in box 1 as income tax wages. As a defense against the market reform penalty, the S corporation may have also included that amount in boxes 3 and 5 subject to Social Security taxes.
Those W-2s may now be amended, along with a Form 941-X (or 943-X for agricultural employers), in order to recover the Social Security taxes. If the payroll taxes involved are not large, some employers may choose not to amend.
Other employee premium reimbursements
For small entities with under 50 employees that are reimbursing employee health insurance premiums (for other than 2 percent S shareholders), the relief opportunities may be greater. The Section 106 tax-free fringe benefit for employer reimbursement of employee health insurance premiums remains in the law. Now that the market reform penalty has been removed for 2014, if an employer actually reimbursed employee premiums, the tax-free exclusion can be claimed. This requires amended Forms W-2 to remove the reimbursement from income tax wages in boxes 1, 3, and 5, and also amended payroll tax reports to recover Social Security taxes paid.
In some cases, if employees have already filed their Form 1040 based on the W-2 issued to them in January, they will be able to amend their 2014 tax return to reduce the taxable wage amount based on the corrected Form W-2.
Going forward, reimbursement of employee-incurred health insurance premiums is generally permissible through June 30, 2015. For more-than-2-percent S corporation shareholder-employees, including the reimbursement as wages for income tax purposes, but not for Social Security tax purposes, is still allowed through December 31, 2015.
How we can help
Talk with your tax advisor if you have questions about amending payroll tax forms.