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Navigating health reform
Restrictions on Employer-Provided Medical Expense Reimbursement Plans
The IRS issued Notice 2013-54 on September 13, 2013, eliminating the opportunity for employers to reimburse most medical costs in all but limited circumstances. The change is effective for plan years beginning on or after January 1, 2014. The notice eliminates an employer’s ability to use a stand-alone medical reimbursement plan, health reimbursement arrangement (HRA), or other tax-favored arrangements, such as a cafeteria plan, to help employees pay for individual health insurance policies or other out-of-pocket medical costs.
“The notice does this by pointing out that these arrangements would fail to satisfy the Affordable Care Act’s (ACA) market reform provisions requiring no dollar limits on essential health benefits and no-cost preventive health services,” says Andy Biebl, a tax principal at CliftonLarsonAllen.
For example, the market reforms prohibit any limit on certain essential health benefits. But stand-alone Section 105 plans limit the amount for which an employee may seek reimbursement. The sanction for violating these rules is a punitive $100-per-day, per-employee penalty, or $36,500 per participant per year — effectively a total prohibition.
Section 105 plans are still permitted for ancillary benefits such as dental and vision coverage, long-term care, and disability coverage, because these are not part of essential health benefits. An employer may still provide pre-tax dollars to the employees in a manner that is exempt to the employee for these reimbursements.
The requirement for unlimited covered benefits does not apply to one-employee medical reimbursement plans. Businesses that have only one employee may continue to offer this benefit. In a very small business in which a family member is the owner’s spouse, the medical reimbursement plan may cover the spouse and dependents of the employee, and thus include the business owner. In this manner, medical expenses, in addition to medical insurance, can be provided on a tax-deductible basis. But Section 105 plans must meet nondiscrimination rules, so these one-employee plans are only practical where there are no other regular employees in the family business.
Integrated Section 105 plans
A Section 105 plan that is coordinated with insurance coverage, so that the combined arrangement provides an ACA-approved group health plan, is permitted if the benefits provide coverage that meets the ACA market reform requirements of unlimited benefits and no-cost preventive services. But a key condition must be met: Each participant in the medical reimbursement plan must be enrolled in the health insurance plan.
These restrictions regarding Section 105 plans are summarized in IRS Notice 2013-54.
New rules for flexible spending accounts (FSAs)
An FSA is a subset of the benefits that may be provided under an employer-sponsored Section 125 “cafeteria” plan (allowing an employee to select from an array of pre-tax benefits such as health reimbursements and day care benefits). Beginning in 2013, a health FSA must limit each employee’s salary reduction contributions to no more than $2,500 per taxable year. These amounts are subject to a use-or-lose rule, under which any unexpended portion is forfeited by the employee. However, a grace period rule has allowed employees to use prior year unexpended amounts for health care expenses incurred for up to two-and-a-half months after the plan year end, if the plan sponsor (e.g., employer) has elected this option.
A health FSA is considered exempt from the market reforms, and thus may continue to reimburse for employer-provided health plans and other health costs, but only if it meets several rules beginning in 2014:
- The employer makes available a group health plan that meets the ACA requirement of unlimited coverage.
- The employer match does not exceed the employee funding for the year. A de minimis rule always allows up to $500 of employer funding.
A health FSA is not permitted to reimburse premiums for health plans offered through an insurance exchange, nor may it reimburse long-term care benefits.
On the positive side, recent IRS Notice 2013-71 allows a health FSA to be amended with regard to the “use-or-lose” rule and the two-and-a-half month grace period. An employer may amend the health FSA to drop the two-and-a-half month grace rule and instead allow up to $500 of undrawn amounts to be carried to the next year. If adopted, this would allow an employee in a health FSA to have up to $3,000 available in a single year ($2,500 from the current year and a $500 carryover from the prior year). Employers must make a choice between the two-and-a-half month grace rule and the $500 carryover rule, and if changing their FSA plan, must amend it by the last day of the plan year beginning in 2014. However, the plan may operate earlier under the new rules.
Providing employer reimbursements denies employee access to exchange subsidies
Beginning in 2014, lower- and middle-income individuals who purchase their health insurance through an exchange, whether federally or state sponsored, are eligible for a premium tax credit subsidy. This subsidy will generally be credited monthly in a manner that reduces the individual’s premium charges through the exchange. Ultimately, this advance credit will be fine-tuned on the individual’s Form 1040 when final income is determined.
In general, the premium tax credit may not subsidize coverage for an individual who is eligible for other minimum essential coverage. All employer-provided health benefits, other than those benefits limited to ancillary items such as dental, vision, and long-term care are considered plans providing minimum essential coverage. Coverage provided through health FSAs, employer payment plans, HRAs, and other Section 105 reimbursements represent employer-sponsored plans and are considered minimum essential coverage. Consequently, employees participating in these accounts do not qualify for exchange subsidies.
The ACA provides government subsidies to individuals who have household income (i.e., generally, the Form 1040’s adjusted gross income) between 100 percent and 400 percent of the federal poverty level. For an individual, this is between approximately $11,500 and $46,000; for a family of four, the amount is between approximately $23,500 and $94,000. A minor employer subsidy of health benefits denies the employee access to these government-provided subsidies. Medical reimbursement plans are hit on two fronts beginning in 2014: The employer faces a stiff penalty due to the market reform limits, and participating employees may not receive subsidized insurance through the exchanges.
Remaining options for employers
For the health plan year beginning in 2014, employers will need to ensure that their employee health offerings conform to ACA mandates. The penalty for noncompliance on a health plan that violates the unlimited coverage and no-cost preventive services is onerous: $36,500 per employee per year. These rules are not affected by the one year delay in the mandate for large employers to provide health coverage.
- A group health plan must meet the ACA unlimited benefits and coverage
- A medical reimbursement plan or similar mechanism that covers employee premiums or other out-of-pocket health costs is not permitted, unless it provides only ancillary benefits (dental, vision, etc.), covers only one participant, or is integrated with a fully qualifying group plan.
- Health FSAs are permitted to cover employee general health costs or premiums, but must conform carefully to the new limits of Notice 2013-71 and must be accompanied by a qualifying employer-provided group health plan.