It’s not business as usual if you are a shareholder of an S corporation which is either paying directly, or reimbursing you, for your individual coverage health insurance premiums. Did you know that changes were required starting Jan. 1, 2014?
Recently an FAQ was issued from the U.S. Department of Labor (DOL) addressing and clarifying previously released guidance in Technical Release 2013-03 regarding employer reimbursements using pre-tax and after-tax dollars to employees for premiums for non-employer-sponsored individual health care plans. (These are also known as Employer Payment Plans (see the article addressing the DOL guidance here. With this issuance, uncertainty has arisen with regard to whether S corporations may still provide a tax-favored reimbursement to more-than-2% shareholder-employees for individual premiums without running afoul of the Affordable Care Act (ACA) market reforms. A little help from a Q&A should help flesh out the issue:
Q: So, what were you trying to say about health care premiums and the Affordable Care Act and S Corporations? I get that the ACA made significant changes to a variety of things regarding health coverage, but please, let’s start with the basics. How did S Corporation shareholders get a tax benefit from reimbursement of their health insurance premiums before the ACA?
A: IRS guidance contained in Rev. Rul. 91-26 and Notice 2008-1 previously provided that more-than-2% shareholder-employees of S corporations — I’ll call them 2% shareholders or shareholder-employees — could deduct the cost of health insurance premiums as an above-the-line deduction under code §162(l) on their tax returns if the corporation either paid the premium directly or reimbursed the 2% shareholder for the cost after the shareholder-employee delivered evidence of such payment to the corporation.
Q: OK, so I’ve got that, but was the corporation able to deduct the amount paid?
A: Yes. The corporation was able to deduct the payment as salary and wages.
Q: So what did that mean for the 2% shareholder? Did they have to report the amount as income?
A: Yes. The shareholder-employee would have to report the payments as compensation on their W-2, which would be subject to income tax withholding requirements. However, the amounts would not be considered wages for Social Security and Medicare tax purposes.
Q: So what types of premiums could be paid? Could the corporation just reimburse the shareholder-employee for premiums that the shareholder-employee paid?
A: The corporation would be permitted to pay premiums for an employer-sponsored group health plan provided by the corporation or even a non-employer-sponsored individual plan entered into by the employee. To qualify for the tax benefits, the corporation just had to follow the previously mentioned formalities, such as the corporation had to include the amount paid in the gross income of the shareholder-employee, and if the corporation didn’t pay the premiums directly, it could reimburse the shareholder-employee for the cost only if the shareholder-employee delivered to the corporation evidence of such payment. Certain other requirements would have to be met for the employee to obtain the deduction under §162(l); like, that the deduction would not be allowed to the extent that it exceeded earned income from the corporation, or if the shareholder-employee was able to participate in any subsidized health plan maintained by another employer of the shareholder-employee or the spouse of the shareholder-employee.
Q: OK, so you’ve provided an explanation of how the law used to be. What has changed as a result of the ACA?
A: Nothing has changed in an arrangement where the corporation is paying a shareholder-employee’s premiums for an employer-sponsored group health plan. That is still allowed whether the corporation is paying the premiums directly or reimbursing the shareholder-employee for the cost of premiums. Where the real change is, is when the shareholder-employee is participating in a non-employer-sponsored individual plan, such as in the Marketplace. In light of the recent guidance provided by the DOL and the IRS that affects Employer Payment Plans beginning Jan. 1, 2014, it is unclear whether such arrangements are still permitted.
Q: How’s that?
A: While it’s somewhat complicated to explain, I will try my best.
To give you a little bit of background, the ACA includes a number of provisions that are referred to as “market reforms,” which are meant to reform the health insurance market. The market reforms include such things as the requirement that a parent’s plan allow coverage for children up to age 26, that certain plans may be grandfathered, the requirement that individuals have a plan that has Minimum Essential Coverage, that individuals be afforded a Patient’s Bill of Rights to help those with pre-existing conditions gain or keep their coverage, as well as other reforms.
The market reforms also include a ban on “Annual Dollar Limits.” Annual Dollar Limits are the total benefits an insurance company will pay in a year while an individual is enrolled in a particular health insurance plan. Starting Jan. 1, 2014, the ACA market reforms banned plans that contained annual dollar limits on coverage of essential benefits, such as hospital, physician and pharmacy benefits.
Q: I understand the ACA market reforms, but how do they impact an S corporation shareholder-employee?
A: The DOL guidance as well as recent IRS guidance, Notice 2013-54 and related FAQ (see a previous article on the IRS guidance here), both of which are based on certain provisions of the ACA, explicitly provide that an Employer Payment Plan is, for ACA purposes, considered a group health plan.
Q: So what is an “Employer Payment Plan”?
A: An Employer Payment Plan is an arrangement where an employer reimburses an employee for non-employer-sponsored health insurance premiums or pays such premiums directly — like one of the tax-favored arrangements that I described for S corporation shareholder-employees.
Q: And the significance of an Employer Payment Plan being a group health plan is …?
A: The ACA market reforms apply to group health plans. As a result, any arrangement that is considered a group health plan for ACA purposes, like an Employer Payment Plan, will be subject to all the requirements found in the market reforms.
Q: So how do the market reforms affect an S corporation paying the shareholder-employees non-employer-sponsored individual health plan premiums?
A: As I stated earlier, as part of the market reforms, starting in 2014 Annual Dollar Limits were banned. An employer payment plan will fail to comply with the Annual Dollar Limit prohibition because 1) an Employer Payment Plan is considered to impose an annual limit up to the cost of the individual market coverage purchased through the arrangement, and 2) the ACA prohibits an Employer Payment Plan from being integrated with any individual health insurance policy purchased under the arrangement.
Q: Let me get this straight. If an employer pays for an employee’s individual health care premiums, whether by paying them directly or by reimbursing the employee, such is considered an Employer Payment Plan. And because such an arrangement is an Employer Payment Plan and therefore considered a group health plan under the ACA, it is prohibited by the market reforms — specifically, the Annual Dollar Limit prohibition? It doesn’t make any sense. Why does it make a difference whether an employer is paying for ACA-compliant group coverage or ACA-compliant individual coverage obtained in an exchange?
A: I understand the confusion — it doesn’t make much sense, does it? To really understand what is happening requires an understanding of the policy behind the rules.
As a result of the ACA, many employers have realized that it may make more sense to drop their group coverage and let their employees purchase coverage in an exchange. However, the Obama administration wants employers to continue to provide coverage to their employees and families — as opposed to effectively “dumping” employees onto the exchanges. Therefore, the IRS and DOL have tried to eliminate any incentive for employers to drop employees off a group plan. For example, while an employer can use an employee’s pre-tax dollars to pay for the employee’s coverage in an employer-sponsored group plan, now payments on an individual policy will have to be paid by the employee using after-tax dollars — typically wages subject to income tax withholdings and employment taxes. The complicated regulations and guidance merely serve as a means to achieve this policy goal.
Q: Thanks. I now at least understand the policy behind the rules, even if I don’t agree with it. So getting back to the S corporation shareholder-employee — the old law for S corporations allowed an arrangement that certainly sounds like an Employer Payment Plan — at least where the corporation would pay the more-than-2% shareholder-employee for individual health insurance premiums if the shareholder and corporation met certain requirements. So is that now also prohibited?
A: Neither the IRS nor DOL have directly addressed whether such arrangements in an S corporation context may still continue. Without any guidance, continuing with such an arrangement in 2014 and thereafter is very risky and should likely be avoided until further guidance is provided.
Q: How risky?
A: The penalties for non-compliance (i.e., continuing such a prohibited plan) may give rise to an excise tax for the employer under Internal Revenue Code section 4980D.
Q: Code section 4980D means nothing to me. What are we really talking about?
A: $100 per day, per employee. Meaning up to $36,500 per year, per employee!
Q: Yikes! Are there any ways around this?
A: Maybe — but only for plans where there is only one participant. The IRS and DOL guidance that I mentioned earlier indicates that a group health plan may not be subject to the market reforms and may continue to be valid under the ACA if there is only one employee participating in the plan. This would potentially allow a shareholder-employee of an S corporation to continue in a plan if they were the sole participant. You have to keep in mind, however, that much of the guidance from both the IRS and DOL specifically addresses single-employee coverage plans in the context of those provided for retirees. Although, there is nothing in the currently available guidance that would indicate that such an exception would not also apply outside a retiree situation. Again, the risk of non-compliance may warrant waiting for further guidance.
Q: I thought death and taxes were supposed to be certain? All of this is riddled with uncertainty.
A: You’re right, there is much uncertainty. Unfortunately, all we can do is wait for more guidance — which will be shared once it becomes available.
Several months later… June 2015
Q: Good to see you again. So, any updates from the IRS regarding treatment of individual healthcare premiums for more-than-2% shareholders of S corporations?
A: Funny you should ask. As a matter of fact, the IRS issued Notice 2015-17 in February that provided an update with regard to the ACA market reform impact to more-than-2% shareholder-employee healthcare arrangements. It offers little in the way of guidance, but does offer some relief.
Q: That doesn’t provide much relief to me if it doesn’t offer any guidance. Can you elaborate?
A: Sure. In Notice 2015-17, or as I will call it, the Notice, the IRS indicates that guidance regarding the treatment of 2% shareholders is forthcoming. In addition, it also provides that until that guidance is issued, and in any event, through the end of 2015, the excise tax under section 4980D will not be asserted for any failure to satisfy the market reforms by a 2-percent shareholder-employee healthcare arrangement.
Q: What about the issue you mentioned before – regarding the ACA provisions being in conflict with prior guidance regarding deductions for 2% shareholder-employees? Did the IRS say anything about that?
A: Well, yes and no. In the Notice, the IRS said that until additional guidance provides otherwise, taxpayers may rely on Notice 2008-1 with regard to the tax treatment provided therein for all federal income and employment tax purposes.
Q: What about the exception that you mentioned before regarding a plan with only one participant? You previously seemed a little uncertain about such an arrangement. Did the IRS offer any guidance there?
A: Yes. The IRS acknowledged that such an arrangement would not be subject to the market reforms. However, they also made clear that if a 2% shareholder-employee and a non-shareholder employee were both receiving reimbursements for individual premiums, the arrangement would be combined to constitute a group health plan and would therefore be prohibited. However, the IRS also indicated if, for example, the non-shareholder employee was covered under the shareholder-employee’s other-than-self only policy, such as a family plan, the arrangement could still be considered a one employee plan.
Q: Anything else?
A: In the Notice, the IRS did address several other issues and provide other types of relief for employers – whether an S corporation or not- for certain types of employer payment plans. If interested, here is an article that provides a summary of all the guidance and relief provided in the Notice. Otherwise, what I mentioned above was all the IRS had to say at this time about the more-than-2% shareholder issue.
Q: So basically it sounds like we are just going to have to wait and see. Thanks for the update.
A: You’re welcome. I’ll keep you posted if anything else comes down the pipeline.