Since the implementation of the Affordable Care Act (ACA), many small businesses owners and managers have been intrigued by the possibility they could discontinue group health insurance and instead offer employees a stipend to purchase individual health insurance policies on their own.
Employers must remain aware, however, that implementing such a plan could violate ACA market reform requirements and subject the business to penalties of $100 per day per employee.
Small businesses could be exposed to such penalties if they provide reimbursements to employees — including owners of pass-through entities — or allow pre-tax salary reduction through a cafeteria plan to pay for individual policies.
The government reasoning behind these rules is that reimbursing employees for their individual insurance premiums creates a group health plan that typically consists of a promise by the employer to reimburse medical expenses up to a certain amount. Such arrangements fail to meet the requirements of ACA because ACA prohibits a limitation on the amount of health insurance premiums and benefits reimbursed to the employee. This issue is problematic for small business employers.
If the small business carries an ACA compliant group health insurance policy and offers it to all eligible employees — including shareholders or partners — this shouldn’t present an issue. But small business owners must remain aware of various new reporting requirements,
There’s an exception if a company only has one employee.
If the employer reimburses this individual for his or her health insurance, this isn’t considered a group plan. Health insurance reimbursement arrangements for fewer than two current employees are excluded from ACA requirements. This is most common in self-employed owner-operated arrangements.
Owners of pass-through entities — specifically, partners in a partnership and those who own, directly or through family members, more than 2 percent of the stock of an S corporation — could face a unique problem under the latest Labor Department guidance for ACA market reform penalties.
The issue relates to the special income tax rule that allows partners and more than 2 percent shareholders to claim the full deduction for their medical insurance on their federal individual income tax returns, specifically on the first page of Form 1040. This special rule is more tax favorable than reporting the health insurance premium expense on Schedule A for itemized deductions, which has the potential to be limited or phased out.
Under the new ACA guidance, this special tax treatment could be a violation. IRS guidance requires the business entity to reimburse the partner or S corporation shareholder for their health insurance premium costs to allow the full health insurance deduction on the owner’s Form 1040.
Recent Department of Labor guidance indicates this is in violation of ACA and could expose the owners of pass-through entities to the $100 per day per individual penalty.
At this point, the only thing we know is there’s a great deal of uncertainty surrounding these issues. Hopefully, the IRS and Labor Department will issue some clarifying guidance to resolve the conflicting opinions. It’s unclear whether or not the IRS and Labor Department will issue new, clarifying guidance in time to issue 2014 W-2s by Jan. 31.
I recommend that all small businesses reimbursing their employees or owners of pass-through entities to discuss these issues with their tax advisors and monitor closely all new information issued regarding the reporting of health insurance premiums for more than 2 percent S corporation shareholders, partners in partnerships and non-owner employees of all business entity types.
Given the potential for sizable ACA penalties, it’s advisable to remain cautious and conservative when determining the appropriate structure for employee health insurance.