Directly reimbursing employees for Affordable Care Act health coverage can be risky
The good news is, small businesses have several options to help their employees get insurance and comply with the ACA
Small-business owners across the country are looking for ways to help their employees obtain insurance. Some employers prefer to directly reimburse their employees for buying their own health insurance, rather than go through the expense of establishing a healthcare plan through the business. But now that the Patient Protection and Affordable Care Act (ACA) is fully implemented, that practice can be risky – leaving the employer liable for penalties in some situations. These penalties aren’t small; they can be as much as $100 per day, per affected employee.
This article outlines the problems inherent with reimbursing employees for insurance premiums, as well as several alternatives that employers should consider.
Directly reimbursing employees for health insurance premiums
The ACA prohibits employers from directly reimbursing employees for some or all of the premiums they paid for a plan purchased on the individual health insurance marketplace. These arrangements are not allowed because they don’t meet two group health plan market reforms, which stipulate that:
- Plans can’t charge for certain preventative care services. If employers are simply giving money to employees, there’s no way to ensure that the employee is receiving preventative care services without paying deductibles or co-pays.
- Plans can’t establish an annual limit on essential health benefits for any individual. Because the employer is reimbursing the individual only for the premiums paid, the employer is considered to be offering a plan that imposes a cost limit that is capped at the amount of the premium.
The consequences of employer direct reimbursement are stiff: Effective June 30, 2015, employers who offer these types of arrangements will be subject to a penalty of up to $100 per day, per employee in such a plan. This penalty adds up quickly and can be as much as $36,500 annually per employee.*
Fortunately, employers have better options to help their employees obtain insurance without necessarily having to establish a health plan. Here are three common arrangements that many small businesses are considering. These alternatives comply with ACA rules and offer several levels of investment that business owners can make. Each option has caveats, however, so employers and their tax advisors should carefully examine the rules and the business’s specific circumstances.
Option 1: Increased employee wages
Employers can increase an employee’s wages to better enable the employee to buy insurance. In these situations, the compensation is fully taxable to the employee for income and employment tax purposes. Employers can’t make buying health insurance a condition of increasing the employee’s compensation. And while employers can’t endorse any insurance provider or policy, they can provide employees with information about the health insurance marketplaces and the availability of premium assistance through premium tax credits and cost-sharing reductions.
Option 2: Payroll deductions
Employers can collect after-tax money for health insurance premiums from the employee’s pay and send payment directly to the insurance company. Employee participation must be voluntary, and employers are prohibited from:
- Contributing toward the payment of premiums.
- Endorsing, advertising, or publicizing the program. Instead, employers can allow insurance companies to publicize the program to employees.
- Receiving compensation for offering the service beyond necessary administration costs.
Option 3: Health reimbursement arrangements
Health reimbursement arrangements (HRAs) allow employers to provide tax-free money to employees for healthcare costs. HRAs are funded solely by the employer, and employees can withdraw the funds to pay for qualified medical expenses incurred during the year. Withdrawals are tax-free as long as employees use the funds to pay for qualified medical expenses for themselves, a spouse, or a dependent under age 27. Any unused amounts in the HRA carry forward to the next year.
For employers, offering HRAs can also mean complying with the ACA’s group health plan market reforms that require free preventative care and no dollar limit on essential health benefits for plan participants. How those reforms are applied depends on the classification of the HRA as standalone or integrated. Integrated HRAs are considered to be minimum essential coverage and comply with the ACA, while standalone HRAs do not.
An HRA is categorized as standalone when the employer offers:
- Only an HRA with no accompanying group health plan, or
- A health plan and an HRA, but the employee can choose to enroll only in the HRA.
Offering standalone HRAs isn’t a wise choice for employers, because standalone HRAs, like employer direct reimbursement, fail to conform to the ACA group health plan market reforms. Employers who offer them will be subject to penalties.
Integrated HRAs are offered alongside a group health plan. For employers to avoid penalties:
- Employees must be required to enroll in a group health plan to receive HRA funds (either through the employer’s group plan or through a family member’s group plan)
- The HRA must either be subject to restrictions on expenses it will reimburse, or the group plan must provide minimum value under ACA rules, and
- The HRA terms must allow employees to forfeit or waive HRA funds when their employment ends.
Integrated HRAs are considered to comply with ACA group health plan market reforms as long as the underlying group plan meets ACA requirements for group plans. Because integrated HRAs meet ACA rules, they are the best option for employers who want to use HRAs.
Many small employers are considering integrated HRAs as a less-expensive alternative that will allow them to offer tax-free help to their employees and avoid penalties. However, employers should be aware that in some cases, employees could fare worse with an HRA than if the employer offered no options at all.
A few factors can create this situation. First, employees can’t use HRA funds to pay health insurance premiums for individual health plans. In addition, employees covered by the HRA are considered to have employer-provided coverage until the HRA funds run out or are forfeited when employment ends. This means that these individuals can’t obtain premium tax credits or cost-sharing reductions through the health insurance marketplace that they might otherwise qualify for. This is also true for taxpayers who still have access to HRA funds, even if they’re no longer receiving HRA funds from an employer.
Business tax credits for offering coverage
Small-business owners considering their options for helping employees obtain insurance coverage shouldn’t forget about the small employer health insurance credit. This credit is worth up to 50 percent of employer-paid premiums. It’s available to small employers (those with fewer than 25 full-time-equivalent employees, with an average annual wage of less than $51,600 per employee in 2015). To be eligible for this credit, employers must purchase a plan through the Small Business Health Options Program (SHOP) and pay at least 50 percent of employee premiums.
Consider the options
Ultimately, small-business owners who want to provide some kind of help to their employees to obtain insurance will need to carefully consider their options and their financial ability. Paying employees more and hoping they obtain insurance is the least-expensive option. Payroll deductions would mean more administrative costs, along with time and effort. And HRAs would require establishing a health plan to comply with ACA reforms, which would be the most expensive option.
Regardless of their choice, employers should ensure that the arrangement doesn’t put them in jeopardy of owing penalties, and they should evaluate whether establishing a SHOP plan for their business would allow them to cut the costs of providing insurance to an affordable level by taking advantage of the small employer health insurance credit.
*Note: S-Corporations using direct-reimbursement arrangements to pay health insurance premiums for more-than-2 percent shareholders won’t be subject to penalties discussed in this article through calendar year 2015. The IRS is expected to issue new guidance in this area later in 2015.