IRS Removes HRA Penalties for Small Employers

On December 13, President Obama signed into law the 21st Century Cures Act, a package of health care legislation that includes a provision that eliminates a tax penalty on small employers that reimburse employees for the cost of health insurance premiums through qualified health reimbursement arrangements (HRAs).

Under the new law, employers that are not classified as applicable large employers (i.e., have more than 50 full-time employees), and are thus not subject to the employer mandate under the Affordable Care Act (ACA), are permitted to compensate employees for the cost of individual insurance premiums or medical visits through HRAs without incurring penalties, provided the employer does not offer a group health plan to any of its employees. The accounts must, however, meet certain criteria. For example, a qualified small employer HRA must be funded solely by an eligible employer, and no salary reduction contributions are permitted under the arrangement. The HRA must also provide for the payment of an eligible employee's expenses for medical care that are incurred by the eligible employee or the eligible employee's family members. The maximum reimbursement under the plan is capped at $4,950, or at $10,000 if the plan provides for the employee's family members.

Moreover, to qualify as a small employer HRA, the arrangement must be provided on the same terms to all eligible employees. However, the act allows benefits under the arrangement to vary based on age and family size variations in the prices of insurance policies in different individual health insurance markets.

In Notices 2013-54 and 2015-17, the IRS had stated that HRAs are employer payment plans that fail to satisfy the market reforms that apply to group health plans under the ACA, and are therefore subject to the excise tax in Sec. 4980D of the Internal Revenue Code. These market reforms include the prohibition on annual limits for essential health benefits and the requirement that the employer provide certain preventive care without cost sharing. Sec. 4980D imposes an excise tax of $100 per day per affected participant (or $36,500 per year, per employee) on health insurance employer payment arrangements that do not comply with the market reforms. In Notice 2015-17, the IRS explicitly recognized that in the past small employers have often provided health coverage for their employees by paying directly or reimbursing the cost of premiums for individual policies, and that such employers "may need additional time to obtain group health coverage or adopt a suitable alternative." The notice thus provided limited transition relief from the assessment of the excise tax for these small employers.

In addition, the legislation coordinates the new exclusion with the Sec. 36B health insurance premium credit to stipulate that employees that are covered by a qualified small business HRA are not eligible for subsidies for health insurance purchased under an exchange during the months that they are covered by the HRA. The new rules apply to years beginning after December 31, 2016, and the transition relief under Notice 2015-17 will be treated as applying to any plan year beginning on or before December 31, 2016.

The National Federation of Independent Business (NFIB) issued a statement praising the passage of the bill. "Both the Senate and the House have now passed critical legislation to protect small business owners from outrageous IRS fines," said NFIB president and CEO Juanita Duggan. "Our research showed that a significant percentage of NFIB members reimbursed employees for the cost of health insurance, a practice the IRS tried to stamp out despite the lack of clear direction from Congress. Now Congress has acted to make it clear that businesses should not be punished just for trying to help their employees pay for health care costs."