11 tax traps for small business health plans
The issue starts out innocently enough: a small business employer simply wants to help employees pay for the cost of health care. So the employer voluntary offers to make a payment for that purpose. That’s where the simplicity ends and the tangle of tax laws comes into play. It is far too easy for an employer to fall into one or more of these eleven tax traps.
Today’s tax rules can trigger bizarre unexpected consequences. This past week I worked with an employer who had simply sent an email out to its 25 employees offering to reimburse part of the cost of health insurance. Even though no payments were actually made to employees the owner was in a panic because of the risk of a potential tax penalty of $212,500!
This post is meant only to list the risks, not to explore each in detail. Note also that this post is meant to address the most common type of employer health plan: common law employees of small businesses. It does not address owner or shareholder issues, one person businesses, large employers, union contracts, leased employees or contracted workers.
- Eligibility for Medicaid – If the employee is eligible for an employer-paid health benefit then Medicaid is generally not available (even if the employer plan provides lower benefits than Medicaid). Businesses and individuals fund Medicaid through taxes to both the federal and state government. This is an absolutely critical benefit to those who need it most. Yet employers may unknowingly disqualify an employee for this valuable benefit by not considering the impact of the health plan.
- Risk for Medicare eligible employees – Medicare secondary payer rules could trigger an employer penalty for offering an incentive to employees to encourage them to take Medicare rather than the employer’s group health plan (even if the employer’s health plan does not provide the level of benefits as Medicare).
- Eligibility for premium subsidies– Millions of Americans are eligible for federal and state health insurance premium subsidies. If the employer makes a contribution then the eligibility for premium subsidies ends. If the employee was already receiving a subsidy then this action could trigger a large amount of the subsidy to be owed back to the IRS when the employer’s reports are electronically matched to the employee’s tax return.
- Eligibility to purchase insurance through the state exchange – Each state has a publicly funded health insurance exchange. Many states have elected to have the federal government-run their exchange through Healthcare.gov. Individuals who are participants in an employer-funded health plan are not eligible to purchase insurance through the exchange even if the employer plan does not provide the same type of benefit as the insurance.
- Taxation of amount received by employee– the amount received by the employee is taxable compensation unless it qualifies for an exemption from tax. Generally a qualified reimbursement under IRC 105(b) and insurance premium payments or reimbursements are not taxable compensation to the employee.
- Employer plan requirements – The IRS and Department of Labor add a number of requirements for a health benefit to be a tax-qualified benefit for employees. Miss any of them any the payments are taxable to employees. Other requirements pertain to reporting of health benefits that can trigger separate penalties on the employer.
- Employees not enrolled in employer group insurance – Health care benefit payments made to employees or on behalf of employees who are not enrolled in the employers group health insurance plan generally trigger an excise tax of $100 per employee per day.
- Individual insurance – amounts paid by the employer for individual insurance trigger an excise tax of $100 per employee per day.
- Not integrated with group insurance – employer payments for health expenses not integrated with an employer-provided qualified group health insurance plan trigger an excise tax of $100 per employee per day.
- Wage tax accounting and penalties – Amounts not properly reported on the employer’s quarterly wage tax return (or other required report) trigger penalties. IRS reports that 1 in 4 small businesses incur these penalties. Each state has its own similar requirements and penalties.
- Confusing terminology – IRS warns that product marketers have introduced terminology that may lure employers into tax traps. For example, the term “healthcare allowance” is actually regular taxable wages and the term “health reimbursement account” is not an account at all but rather just an accounting notion. Misinterpretation can be costly to employers and employees.
I recommend that employers arrange a formal written review of their employee health arrangements by a qualified tax professional before the end of 2015 to ensure compliance with the law. Even if the harsh $100 per employee per day penalty is softened (as we expect it will) the remaining penalties will still be substantial.