The Affordable Care Act Just Became Less Affordable
2014 marks the first full year in which Americans are expected to follow the Affordable Care Act (ACA) to comply with the individual medical insurance mandate. This has been a year of change, both good and bad, as we work to determine the far reaching implications of this Act on individuals and businesses in America.
One area that is not covered in the media or in political campaigning relevant to many small business owners is how medical insurance premiums are treated for payroll taxes. Failure to comply with the standards set by the IRS can mean a $100 per person per day penalty for each employee in non-compliance. That adds up to $36,500 a year, per employee!
At issue is how the reimbursement of individual insurance policies is treated for tax. The IRS’s standpoint is that if you reimburse medical insurance premiums on a pre-tax basis outside of a group policy, you have created an illegal Section 105 plan, otherwise known as a medical reimbursement arrangement. This is a provision that has not been publicized, largely because there is very little guidance on it. Notice 2013-54, which briefly overviews the issue, was published by the IRS in late 2013.
At the end of 2013, when medical group plans were in the renewal process, many healthy groups found that the cost of their policies were jumping in price by 20 – 40%, and deemed not affordable. The solution? Buy the employees individual plans for a reasonable amount and eliminate the proposed unaffordable group plan. A similar strategy was to pay the employees an amount that was similar to the employer contribution under the group plan and let them choose a policy from the marketplace. Both of these options are acceptable, but only as long as you comply with the other components of the ACA.
The catch is how the employer payment of an individual medical insurance premium is treated for the owner and the employee. This is no longer a pre-tax event and the amount paid for medical insurance MUST be subjected to all payroll taxes as well as federal and state income tax. The amount paid on behalf of an employee for an individual medical insurance policy or the amount paid for him to purchase his own policy is now considered additional compensation. With that slight change in rules, the group plan might be more competitively priced than it first appeared.
To test if you are in compliance with the new rules, follow the decision tree below:
*Individuals without insurance may be subject to the individual mandate penalty, depending on their income level. Large employers not offering insurance are subject to the employer mandate penalties.
To illustrate a real example of how this could impact not only small businesses, but also their employees, consider the following example:
Company XYZ has historically offered a group medical insurance package. The company pays for 80% of the benefit as a perk for the employees, the employees pay the remainder. The most recent renewal includes an increase in premiums of 30% with no plan design change. The increase in premiums is not affordable and the company decides to pay their employees to purchase their own policies. The employer decides to pay the same amount in total dollars to the employees, but now that is considered wage, subject to payroll tax. The employee is now receiving more wages that are subject to payroll tax, federal and state income taxes, so the purchasing power is only approximately 70% of the employer’s former power. Not only does this option cost the employer more money for the same policy, it also causes the employees to be out significantly more cash in order to purchase medical insurance.
Possible scenario of switching from a group plan to an individual plan under ACA:
In summary, when it comes to evaluating medical insurance options, it is important to consider the whole cost.There are tax consequences for changing course and we can help you make that decision. For advice or assistance in complying with the Affordable Care Act, please call us.
Note: If you need to make a change to your payroll to be in compliance for 2014, we recommend making the correction as soon as possible so that your payroll processor has adequate time to make the correction and you can split the payroll tax consequence across multiple payrolls.