ACA Clarification Reveals Potential Tax Penalties for HRAs

Employers with medical reimbursement plans such as health reimbursement arrangements (HRAs) need to review them as soon as possible, to make sure they don’t accumulate heavy tax penalties from noncompliance with Affordable Care Act (ACA) rules.

According to recently clarified federal guidance, employers that reimburse their employees for health care costs can face significant penalties if the reimbursements do not follow ACA implementation rules that went into effect in 2014. The rules apply to employers of all sizes, including nonprofits.  

The guidance was issued jointly by the Departments of Labor, Health and Human Services, and the Treasury in November 2014. It clarifies the earlier IRS Notice 2013-54 and says that reimbursement arrangements are subject to the same legal requirements as a group health plan.

Beginning with the 2014 plan year, employers that don’t follow these rules face a penalty of up to $100 per day excise tax, per employee, plus any applicable wage taxes, interest and related penalties. The minimum penalty for an unintentional violation is 10% of the reimbursement amount.  Note that this penalty is not related to the ACA’s Employer Mandate.

The rules say that:

• Employers cannot use the HRA to pay for employees’ premiums for individual market coverage.
• The HRA must be used with an employer-provided ACA-compliant group health plan. (There are also specific requirements for how to integrate the two.)    
• Stand-alone HRAs are prohibited.
• Employees cannot use the HRA if they waive their health coverage or have other non-employer-provided insurance.
• If an employee is covered by a spouse’s plan, employers may not reimburse the cost of this coverage.
• Employees cannot make voluntary, salary-deducted contributions to an HRA.

These requirements apply regardless of whether the reimbursements are made on a pretax or after-tax basis.

Exceptions
The rules do not apply to limited scope vision and dental plans or to one-employee plans. (Note that IRC Sec.105(h) nondiscrimination rules essentially require that all full-time employees participate in a medical reimbursement plan.)

Alternatives to reimbursing individual coverage
The rules prohibit employers from reimbursing employees for individual health insurance, unless it’s a one-employee plan. Employers instead can:

• Provide a tax-free benefit by buying an ACA-approved, employer-sponsored group health plan; they can also set up a cafeteria plan for pretax funding of the employee part of the premium.
• Increase employees’ taxable wages to provide funds they can use to pay for individual health insurance (although employers can’t require employees to use the money for this purpose.)  The employer can claim a deduction for the wages paid. The wages are taxable to employees, but they can claim the premiums as an itemized deduction.

Review your plan now
If your business is in violation of the guidelines, you need to act promptly to avoid additional penalties. You may need to revise or even terminate your HRA and/or make payroll tax adjustments. We recommend you contact Dan Jones, Armanino Tax Partner, as soon as possible to discuss the new guidance and how it affects your business.