Health Insurance Reimbursements: What You Can and Cannot Do

Blog_12-8-15_CanDo_dreamstime_xsSince the advent of the Affordable Care Act, small businesses have scrambled to find ways to make sure their employees have health coverage. Many have found it impossible to offer their own coverage because of price. They have tried to find other alternatives. The IRS isn’t making it easy.

Reimbursements for individual coverage

As I’ve written about before, the IRS has said that reimbursing an employee for his or her premiums is a violation of the law that results in a $100 per day per employee penalty. Earlier this year, the IRS said it would not impose the penalty on these reimbursements through June 30, 2015. No further guidance has been provided despite calls from small business owners and advocacy groups for additional relief.

Permissible. You can increase a worker’s pay with the idea that he or she will use the money to obtain health coverage. As long as the added amount isn’t conditioned upon using it to buy the coverage, this is one way to help employees obtain coverage. They may be able to obtain it through HealthCare.gov and qualify for a subsidy in the form of the premium tax credit, costing them less than they might otherwise have to pay as their share of any employer-provided coverage. Of course, the additional pay is obviously taxable compensation, and subject to employment taxes.

Reimbursements for coverage under a spouse’s plan

Some small businesses offer coverage but employees may decline because they can get better, or cheaper, coverage through a working spouse’s plan offered by his or her employer. The IRS has ruled that if the working spouse pays for the added cost of the employee on an after-tax basis, then a reimbursement of this cost is tax free to the employee (and free from employment taxes). It has provided six scenarios, some of which are after-tax and some of which are pre-tax to the working spouse. The IRS said that “[t]he fact that the insured group health plan is provided by [the spouse’s] employer and not by [the employee’s] employer does not change the results.”

Take this case (based on one of the IRS’s scenarios). Say you have an employee, A, who has a working spouse, B. B receives self-only coverage from her employer but is allowed to buy coverage for a spouse; she pays out-of-pocket to cover A. A receives a reimbursement from his employer to cover the spouse’s out-of-pocket cost. This is treated as tax-free employer provided health coverage for A; the reimbursement is not income to him even though the coverage is through another employer’s plan.

If, however, the spouse pays for the coverage on a pre-tax basis (i.e., through a cafeteria plan), then the employee is taxed on the reimbursement and the reimbursement is subject to employment taxes.

What does this informal IRS ruling tell us? In all of the situations described in the informal ruling, the employer offered some type of coverage. There was no stand-alone reimbursement offered. Because this informal ruling followed the expiration of the penalty relief described earlier, does this mean that a reimbursement arrangement for small businesses offering some type of coverage that fits one of the IRS-approved scenarios escapes the penalty? You tell me.

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