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IRS Clarifies $36,500 Health Care Reform Penalty

Offering a Stand-Alone Health Reimbursement Arrangement Can Be Costly

The Employer Shared Responsibility tax penalties are not the only Affordable Care Act (ACA) penalties getting the attention of plan sponsors. Recent guidance from the Internal Revenue Service (IRS) about a $36,500 penalty has many taking notice.

In September 2013, the IRS released regulations that addressed the issue of stand-alone Health Reimbursement Arrangements. In May 2014, the IRS followed up with additional guidance through a Question and Answer document that spelled out the rules in more detail.

The issue is whether there are consequences for employers that choose not to establish a health insurance plan for their employees, but instead make tax-free reimbursements to employees for premiums they would pay for insurance, either through a public Marketplace (Exchange) or outside the Marketplace.

The IRS FAQs explain that such an arrangement is not allowable, because it is considered a stand-alone group health plan that is subject to ACA market reforms. These reforms include:

  • No annual limits
  • Maximum waiting period of 90 days
  • No pre-existing condition limitations
  • First dollar coverage for preventive care
  • Medical loss ratio guidelines
  • Coverage for adult children up to age 26
  • Maximum out-of-pocket limits
  • Deductible limits

Combining a tax-advantaged plan (like a Health Reimbursement Arrangement) with a plan that does not include market reforms could make the employer subject to an excise tax of $100 per day, per employee ($36,500 per year). If the company is an ACA Applicable Large Employer, this would potentially be in addition to the “pay-or-play” penalty of $2,000 for each full-time employee (a.k.a. Employer Shared Responsibility mandate). This provision applies to active employees, but not retirees.

Some plan sponsors may choose to avoid the excise tax by putting the money they would normally direct to a Health Reimbursement Arrangement into employee salaries. However, the additional salary would be taxable income to the employee, and because it would be considered earnings, the additional income could impact the individual’s level of subsidy for which he or she might qualify in the public Marketplace.