Be Careful About Employee Reimbursement of Health Insurance Premiums – or Face Staggering IRS Penalties Under the ACA

If you’re a small business owner, you might think that offering to pay for (or reimburse) the cost of your employees’ health insurance would be a good thing. But the IRS feels otherwise under the Affordable Care Act (ACA) rules.

Not only are you prohibited from assisting employees under so-called “employer payment plans,” but you could also face costly penalties as a result.

As of July 1, 2015, when IRS transitional relief ran out, you’re now subject to a tax penalty of $100 per day, per employee if you continue to pay for employees’ individual premiums. (In fact, non-compliance for a full year could result in penalties as high as $36,500 per employee.)

Don’t get burned by this new rule. Here’s some additional explanation on who it affects, what it means and what you can do to comply.

How Many Employees Do You Have?

This employer payment plan rule affects small employers, or those with less than 50 full-time or full-time equivalent employees. According to the IRS, an employer payment plan is one where you reimburse employees directly for individual health insurance policies, or pay for their premiums outright.

What typically happens is your business doesn’t provide group health insurance coverage, so you offer employees money so they can go to the marketplace or exchange and buy health insurance on their own.

Before the passage of the ACA, many small employers would go this route to avoid the cost and complexity of setting up and administering a group health insurance plan. The ACA, however, changes this with the mandates that all Americans purchase insurance and that all businesses of a certain size offer health insurance. And since employers with 50 or more employees are already required to offer affordable health insurance under the ACA, this particular rule specifically affects small employers under the 50 full-time employee threshold.

A Rule with Far-Reaching Implications

If you weren’t aware of this rule, don’t feel bad. It’s a particular ACA provision that isn’t getting a lot of coverage. “It’s the biggest penalty that no one is talking about,” said Kevin Kuhlman, policy director for the National Federation of Independent Business.

“Biggest penalty” indeed. Beyond the potential $36,500 price tag per employee, there’s a total maximum of $500,000 per year.

For example: If you’re a company with nine employees and you reimburse each employee for the cost of his or her individual health insurance premium, you could face a penalty of $328,500 ($36,500 for each of the nine full-time employees).

Compare this to the $2,000 fine that affects applicable large employers (ALEs) that don’t comply with the ACA employer mandate, and you realize how serious the employer payment plan rule is for your small business. To avoid a heavy financial hit, it’s important to follow the latest requirements.

What to Do Next to Protect Your Business

To avoid crippling tax penalties under section 4980D of the Internal Revenue Code, you have two key options:

• Provide an ACA-approved, employer-sponsored group health plan, including those through the SHOP Marketplace — You can take advantage of a cafeteria plan for pre-tax funding of the employee portion of the premium, which reduces income and FICA taxes for the employee (and payroll taxes for your business).
• Increase employee compensation to help workers pay for individual health insurance — Keep in mind you can only do this if you make employee participation voluntary (in other words, you can’t require the extra funds to be used for this purpose) and you don’t endorse a particular insurance company.