Q: I run a small business in Boise and have five employees. To keep costs down I offer a medical insurance plan with a high deductible, so I also give my employees a little extra cash (up to $1,000 per employee) to help cover their out of pocket medical costs. My insurance agent told me this is not taxable to my employees, but that there is some other tax that I need to pay. Can you tell me about this other tax?
A: There are actually a couple issues you need to address with your Health Reimbursement Arrangement (HRA). This type of arrangement is very common in small business and is considered a self-insured health plan subject to a number of restrictions and a “fee.” These rules also apply in the case where an employer reimburses an employee for substantiated non-employer sponsored medical insurance premiums and other medical costs..
First, the HRA payments to your employees are indeed not taxable to them as long as the payments are made for substantiated medical expenses. Better still; the payments are tax deductible for you the employer. This is one of the few very taxpayer friendly rules in the tax code.
The Affordable Care Act (ACA or Obamacare) contains a number of provisions designed to standardize medical insurance coverage. These “market reforms” include rules that prohibit a group health plan from establishing annual limits on the dollar amount of benefits for any individual, and also a requirement that group health plans provide certain preventive services without any cost-sharing requirements for these services. On the surface it would appear that your HRA could violate one or both of these rules unless the HRA is considered to be “integrated” with your regular medical insurance plan (i.e., a condition to participate in your HRA is that the employee participates in your group health insurance plan, or another group health plan such as a spousal plan). These integration rules are very complicated and far too long to detail in this article, but I strongly recommend you touch base with a knowledgeable health insurance professional about this to make sure you are in compliance.
If you don’t comply with the rules and violate the market reforms provision you could be subject to a substantial penalty. That penalty is $100 per day per employee!!! That’s $36,500 per employee for a full year of noncompliance. That is a very steep penalty and one that will catch many small employers unaware.
But, assuming your plan is integrated so that it can be retained without the onerous penalty, you will need to deal with the new ACA fee. The fee is meant to fund the Patient-Centered Outcomes Research Institute (PCORI), a new initiative to improve health decisions by advancing comparative clinical effectiveness research. This PCORI fee is assessed on self-insured health plans with more than one employee including plans similar to your HRA.
The fee is calculated by multiplying the average number of “lives covered” for the plan year by the rate of tax which is only $1 for plan years that ended between October 1, 2012 and October 1, 2013, and $2 for plan years that end between October 1, 2013 and October 1, 2014. The rate hasn’t be established yet for future plan years. The calculation of “number of lives covered” is, of course, complex and you should refer to the form instructions for help.
The fee is paid by filing Form 720, Quarterly Federal Excise Tax Return. The six-page form is full of all sorts of excise taxes and might provide a few minutes of light entertainment when you see everything our government taxes. But for the PCORI fee you need only look to page 2 of the form, Part II, IRS no. 133, for the two lines that are applicable in this case. Normally Form 720 is due quarterly, but for the PCORI fee an annual report is filed and is due July 31. And there is no de minimis exception for small employers; even a small business that only has one or two covered lives is still required to submit the Form 720. But the good news is the IRS announced the small fee that you will owe is tax deductible.
Next week’s question: Why doesn’t Congress just charge every small employer a $100 fee for existing and avoid all this complexity?
To ensure compliance imposed by IRS Circular 230, any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed by governmental tax authorities. The answers in this column are meant to offer general information. You should consult your tax adviser regarding the specifics of your situation. Peter Robbins is a partner in the Boise office of CliftonLarsonAllen LLP, specializing in tax matters for small businesses, individuals, and trusts and estates. Have a question for Robbins? Email your question to email@example.com. Enter “Talking Tax” in the subject line.