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Will Your Clients Run Afoul of ACA's Largest Penalty?

love jerryFailure to read this article and understand it could cost your client or company a penalty of $100 per day per employee under Code § 4980D. The penalty could be $36,500 per year per employee for employers who do not offer insurance coverage, but instead seek to reimburse their employees for insurance purchased on the individual market. This penalty could put you or your small business clients out of business. This IRS Revenue Ruling went into effect on July 1, 2015.

This is a very serious matter which many professionals have been hoping the IRS would further delay or Congress would fix, however neither has happened. I am finding many small employers think because they have less than 50 employees there is nothing in the Affordable Care Act (ACA) which will impact them. However, this penalty can be assessed to employers with as few as two employees. The IRS is sending a strong and clear message to employers who are sending their employees to a health insurance exchange or the open insurance market with a tax-free contribution to help them pay premiums. Many small employers have used payment arrangements such as reimbursing the employee for premiums or making the payment directly to the insurance company to help employees obtain health coverage without the hassle and expense of furnishing a full-fledged company group health insurance plan. Sometimes employers have done this because they could not obtain an affordable group policy or they may not have enough employees to meet the insurance companies’ criteria. According to the IRS, this penalty can be assessed to employers for simply offering plans which reimburse employees for premiums paid by them for individual health insurance policies. The penalty can also apply to direct employer payments of premiums for employees’ individual health policies.

National Federation of Independent Business (NFIB) reported this summer (June 18, 2015):
“Businesses of all sizes will have to pay a daily $100 penalty if they are reimbursing their employees for individual market health insurance premiums starting July 1, 2015.

Unlike early reports that the Affordable Care Act would only affect larger companies, this penalty applies to any company that reimburses more than one employee. The penalty is $100 per day per employee, up to $500,000.

This penalty is just one of many ACA changes that biz owners have to look out for in the near future.”

http://www.nfib.com/article/biz-owners-avoid-a-100-per-day-penalty-69862/

The NFIB continued its reporting of this issue on June 29, 2015 in an online article by Jack Mozloom:
An obscure IRS rule takes effect on Wednesday under which small businesses that get caught helping their workers buy insurance or pay medical bills can be fined 18 times more than larger employers that don’t provide coverage at all, warned the National Federation of Independent Business (NFIB) today.

“It’s the biggest penalty that no one is talking about,” said NFIB Policy Director Kevin Kuhlman. “The penalty for compensating employees for healthcarerelated expenses is enough to destroy most small businesses.”

Under the rule, which appears nowhere in the Affordable Care Act, employers who do not offer a group health plan, but give their workers additional pay to compensate for the purchase of health insurance or direct medical expenses can be fined $100 per day, per employee. Over the course of a year that’s $36,500 per employee up to $500,000 in total.

“It’s hard to believe Congress or the President intended to punish employers much more severely for actually helping their workers,” said Kuhlman. “Nevertheless, that’s the consequence and most small businesses don’t know it.”

In fact, according to NFIB research 14% of small businesses that don’t offer group insurance reimburse their workers instead. They think they’re doing a good thing but they’re walking into a minefield.

“Reimbursing employees for the cost of insurance or medical services is a way for small businesses to help their workers without the administrative headache of setting up a costly group plan,” said Kuhlman. “Most small employers don’t have HR departments or benefits specialists, so this is a simpler, easier way to help their employees.” http://www.nfib.com/article/suranc-69940/

This penalty is huge. It is more than 18 times greater than the $2,000 employer- mandate penalty under ACA for not providing qualifying health insurance for employees. It is very important to note employers with fewer than 50 workers are not exempt. The basic issue is how an employer may be paying for an employee’s health insurance. Many small employers will reimburse their employees for premiums on their individual health insurance policies or the employer may pay the premium directly on behalf of the employee. These arrangements have long been popular with small employers who want to offer health insurance but are unwilling or unable to purchase group health coverage.  

Clearly ACA was written with the intention of getting everyone in America health insurance.  Further ACA has a clear mandate to the larger employers (those with over 50 full time employees (FTE)) to provide health insurance which is affordable to all of their full time employees. According to the IRS and Department of Labor (DOL) these individual market policies cannot be integrated to meet the market reform provisions. Specifically, the IRS stated these plans violate the Essential Health Benefits provision of the ACA, as well as the prohibition on spending caps on these mandatory benefits.

The Centers for Medicare & Medicaid Services (http://www.cms.gov/) provides the following information in their Affordable Care Act Implementation FAQs:

“Q. May an HRA used to purchase coverage on the individual market be considered integrated with that individual market coverage and therefore satisfy the requirements of PHS Act section 2711?

"A. No. The Departments intend to issue guidance providing that for purposes of PHS Act section 2711, an employer sponsored HRA cannot be integrated with individual market coverage or with an employer plan that provides coverage through individual policies and therefore will violate PHS Act section 2711."

Section 2711 of the PHS Act, as added by the Affordable Care Act, generally prohibits plans and issuers from imposing lifetime or annual limits on the dollar value of essential health benefits. The preamble to the interim final regulations implementing PHS Act section 2711 (75 FR 37188) addressed the application of section 2711 to health reimbursement arrangements (HRAs) and certain other account-based arrangements. HRAs are group health plans that typically consist of a promise by an employer to reimburse medical expenses (as defined in Code section 213(d)) for a year up to a certain amount, with unused amounts available to reimburse medical expenses in future years. The preamble distinguished between HRAs that are "integrated" with other coverage as part of a group health plan and HRAs that are not so integrated ("stand-alone" HRAs). The preamble stated that "[w]hen HRAs are integrated with other coverage as part of a group health plan and the other coverage alone would comply with the requirements of PHS Act section 2711, the fact that benefits under the HRA by itself are limited does not violate PHS Act section 2711 because the combined benefit satisfies the requirements." (75 FR 37188, at 37190-37191). The corollary to this statement is that an HRA is not considered integrated with primary health coverage offered by the employer unless, under the terms of the HRA, the HRA is available only to employees who are covered by primary group health plan coverage provided by the employer and meeting the requirements of PHS Act section 2711.”

The IRS issued Notice 2013-54 in September 2013 which addressed the issue of an employer providing a pre-tax reimbursement for an employee’s individual health insurance premiums. In this Notice, the IRS clarifies their position that these employer pre-tax payment plans are considered group health plans under ACA. Therefore, the IRS is taking the position these pre-tax arrangements are group health plans (either through a qualified health plan in the Marketplace or outside the Marketplace). Therefore if these arrangements are group health plans then they are subject to the ACA market reforms, including the prohibition on annual limits and the requirement to cover preventive care without cost-sharing. These arrangements cannot be integrated with individual health insurance plans in order to satisfy the market reform requirements.

http://www.irs.gov/Affordable-Care-Act/Employer-Health-Care-Arrangements

Further the IRS Notice 2013-54 explains:
“how the Affordable Care Act’s market reforms apply to certain types of group health plans, including health reimbursement arrangements (HRAs), health flexible spending arrangements (health FSAs) and certain other employer healthcare arrangements, including arrangements under which an employer reimburses an employee for some or all of the premium expenses incurred for an individual health insurance policy.”

On February 18, 2015, the IRS issued Notice 2015-17:
“provided temporary relief from the § 4980D excise tax for failure to satisfy the Affordable Care Act market reforms such as the prohibition on annual limits.  Under the notice, small employers with employer payment plans got relief for 2014 and up to July 1, 2015.

... reiterates the conclusion in previous guidance addressing employer payment plans, including Notice 2013-54, that employer payment plans are group health plans that will fail to comply with the market reforms that apply to group health plans under the Affordable Care Act.  Notice 2015-17 also provides transition relief from the assessment of the excise tax under § 4980D for failure to satisfy market reforms in certain circumstances.”

The IRS Notice 2013-54 indicates these employer payment plans are considered to be group health plans subject to the market reforms, including the prohibition on annual limits for essential health benefits and the requirement to provide certain preventive care without cost sharing. The notice further clarifies that such arrangements cannot be integrated with individual policies to satisfy the market reforms.

It is very important we take note the heart of this issue is the employer reimbursement or directly paying the premium for the employee’s individual plan. Under IRS Notice 2013-54, such arrangements are described as employer payment plans. Therefore, small businesses (with as few as 2 employees) who reimburse employees for the cost of premiums for individual health insurance policies or pay their health costs directly can be fined up to $36,500 a year per employee under this Internal Revenue Service regulation that took effect July 1, 2015. 

According to the notice, an employer arrangement that reimburses or pays for employee individual health premiums is considered to be a group health plan that is subject to the $100 per-employee per-day penalty. The penalty applies whether the reimbursement is considered a before-tax or after-tax contribution. I will address some options the employer can consider later in this article.

Penalty Exception if Only One Employee

The penalty will not apply if only one employee is reimbursed for individual health insurance and/or other medical expenses. However, be cautious of the potential land mines discussed later.

Shareholders of Sub S Corporation Exception

Per the IRS:

“Notice 2015-17 also clarifies that S corporations may continue to report reimbursements of health insurance of 2% (or greater) shareholders pursuant to Notice 2008-1. Until further guidance is issued, and in any event through the end of 2015, the excise tax under Code § 4980D will not be asserted for any failure to satisfy the market reforms by a 2% shareholder-employee healthcare arrangement.”

In addition to the potential penalty from the IRS there is also a potential liability as a result of additional DOL enforcement of compliance with the market reforms, incorporated into ERISA by the Public Health Service Act (PHSA).  Per the IRS website:

“DOL has issued a notice in substantially identical form to Notice 2013-54, DOL Technical Release 2013-03. On Jan. 24, 2013, DOL and HHS issued FAQs that address the application of the Affordable Care Act to HRAs. On Nov. 6, 2014, DOL issued additional FAQs that address the application of the Affordable Care Act to HRAs and other payment arrangements.”

What options do small employers have?

What can an employer do? To avoid penalties under the Affordable Care Act, consider the following options starting with your health plan year beginning after July 1, 2015:

1. First it is noted companies with only one participating employee will not face the $100 per employee, per day penalty. It should be noted nondiscrimination rules would require that essentially all full-time employees must participate in the plan. So even though there appears to be a technical exception for covering only one employee, a company who believes this exception is applicable to them would be well advised to seek professional advice and analysis.

2. Furthermore Sub-S corporations are exempt from the penalty through December 31, 2015 for those employer payment plans that affect the shareholders who hold 2% or more of the stock.

3. Provide an ACA approved group health plan.  If the employer does not meet the definition of a Large Employer with more than 50 FTE, the employer can pay all or any portion of the premium. The small employers with 50 or fewer FTE can provide a group health plan through the SHOP Marketplace. When an approved group plan is used, a cafeteria plan can be utilized for pretax funding of the employee portion of the premium (saving both income and FICA taxes for the employee, and payroll taxes for the employer).

4. Increase the compensation for some or all employees, withhold the health insurance premiums from their wages, and forward the premiums on an after-tax basis to the insurance companies. This is permissible as long as:
(a) You do not pay any premiums other than those withheld,
(b) Employee participation is voluntary; and
(c) You do not endorse any insurance company and do not receive any cash or non-cash considerations from an insurance company.

5. Because this will be a payroll issue, nondiscrimination rules will not apply and you will not have to treat all employees the same.

6. Integrated HRA – These are HRAs which are coupled with an employer’s group health plan like many employers currently established under high-deductible health plans for reimbursement of copay and deductibles.

As indicated by the NFIB, this may be the biggest penalty in the ACA that nobody is talking about. We as CPAs are at risk of not educating our clients or the companies that employ us.


Jerry Love is the sole owner of Jerry Love CPA, LLC in Abilene, Texas. He graduated from Abilene Christian University. In addition to being a CPA, he has also earned the designations of PFS, CFP, CVA, ABV, CITP, CFF, and CFFA. In 2006-07, Jerry was the Chairman of the Texas Society of CPAs.