The Affordable Care Act—Countdown to Compliance for Employers, Week 30: The IRS Tells Us that Employer Payment Plans (Really, Really, Really) Don’t Work
The IRS recently issued two Q&As on the subject of employer payment plans, the purpose of which was to again underscore that arrangements purporting to allow an employer to reimburse employees on a pre-tax basis for premiums used to purchase health coverage in the individual market (either inside or outside of a public exchange) violate certain of the Affordable Care Act’s insurance market reforms.
The reforms which the IRS has in mind are:
Public Health Service Act § 2711, which generally bars group health plans from imposing annual or lifetime limits on the dollar amount of benefits (the “annual dollar limit prohibition”); and
Public Health Service Act § 2713, which requires non-grandfathered group health plans to provide preventive services without imposing any cost-sharing requirements (the “preventive services requirement”).
The general reaction among employers to these Q&As was something like, “yeah, we know that… you folks have already made that clear” or something to that effect. Many wondered why the IRS bothered with these Q&As since the matter appeared to be well-settled in IRS Notice 2013-54, which we wrote about here. But it appears that not everyone got the memo—which is what likely prompted the IRS to act. And to drive the point home, the Service noted that an employer sponsoring an offending arrangement will be subject to a $100/day per employee penalty.
The issue of whether pre-tax employer and employee contributions might be applied to the purchase of individual market coverage was first raised in a June 28, 2010 interim final regulation implementing the annual dollar limit prohibition. While this regulation provided that a “stand-alone” health reimbursement account (HRA) would not satisfy the annual dollar limit prohibition, it did not explain exactly which arrangements were (or were not) stand-alone. Further complicating the matter, the annual dollar limit prohibition (as set out in Public Health Service Act § 2711) does not apply to health FSAs within the meaning of Code § 106(c)(2). (Without this statutory exception, health FSAs would no longer exist.) Nor did the interim final regulations address the impact of Revenue Ruling 61-146, under which, if an employer reimburses an employee for the cost of coverage for an individual market policy, the amount of the employer reimbursement may be excludable from gross income under Code § 106.
These omissions led some promoters to continue to market stand-alone heath reimbursement arrangements claiming that their particular product met one or more of these exceptions. This, despite that most if not all of these products would—at least in our view as subsequently confirmed by the IRS—violate the annual dollar limit prohibition and the preventive services requirement under a fair reading of the interim final regulations. The IRS initially responded with a frequently asked question issued January 24, 2013 (FAQs about Affordable Care Act Implementation Part XI, Q&A 3), saying:
Q3: If an employee is offered coverage that satisfies PHS Act section 2711 but does not enroll in that coverage, may an HRA provided to that employee be considered integrated with the coverage and therefore satisfy the requirements of PHS Act section 2711?
No. The Departments intend to issue guidance under PHS Act section 2711 providing that an employer-sponsored HRA may be treated as integrated with other coverage only if the employee receiving the HRA is actually enrolled in that coverage. Any HRA that credits additional amounts to an individual when the individual is not enrolled in primary coverage meeting the requirements of PHS Act section 2711 provided by the employer will fail to comply with PHS Act section 2711.
This Q&A was followed later in the year with Notice 2013-54, which addressed the questions raised under Code § 106(c)(2) (the FSA exemption is only applicable to FSAs offered through cafeteria plans) and Rev. Rul. 61-146 (imposing new limits on “employer payment plans”). Notice 2013-54 also established clear rules on what it means for a plan to be “integrated” vs. “stand-alone,” and it provided some welcome transition relief. To call Notice 2013-54 “definitive” is something of an understatement. In it, the IRS systematically dismantled the basis for any arrangement intended to circumvent the intent, if not the letter, of the 2010 interim final regulations.
A short while before the issuance of the Q&As, there was a lively discussion on a LinkedIn message board on the subject of employer payment plans. The exchange started with a version of the title of this post, viz., employer payment plans really don’t work. There followed varying degrees of dissent. That this discussion occurred at all demonstrates that Notice 2013-54 did not have the intended effect in all quarters. This is particularly troubling because, as the IRS has taken pains to point out, the penalties for running afoul of these rules are steep.
More troubling is that these penalties are self-reported (see our earlier post on the subject of penalties), and they apply to large and small employers alike. Thus, employers to whom employer payment plans have been sold as fitting this or that exception to Notice 2013-54 are already subject to penalties. Regrettably, it’s a safe bet that these sorts of violations will occur predominantly in small employers with less access to reliable professional advice.
Despite what appear to be clear rules on the subject of employer payment plans, a handful of vendors continue to press ahead offering arrangements under which an employer reimburses employees on a pre-tax basis for premiums used to purchase health coverage in the individual market, with claimed impunity. One recently called to our attention involves what is touted as an “alternative to an Employer Payment Plan that allows tax-free reimbursement of individual health insurance costs.” Under this alternative, an employer “reimburses employees for medical care (including health insurance premiums).” The promoter claims that reimbursements are then excludable from employees’ taxable income. This prompts us to offer the following observations:
If there is a difference between this arrangement and an offending employer payment plan, we are at a loss to see it;
The IRS’s recent Q&As on the subject, while perhaps duplicative, are (at least in our view) necessary. Unlike formal agency guidance, which is sometimes difficult to understand let alone find, these Q&As are in plain English and they are readily available; and
Arrangements that purport to allow an employer to reimburse employees on a pre-tax basis for premiums used to purchase health coverage in the individual market (either inside or outside of a public exchange) do not work as advertised—period, paragraph, end of discussion.