Reimbursement of Individual Plan Premiums by an Employer: The Issue and How to Deal with Clients Impacted by It

An important new notice was issued on February 18 that provides relief for many affected taxpayers through June 30, 2015.  See the write-up elsewhere on this site regarding Notice 2015-17.

Much confusion and angst has resulted from the recent discovery by some of the impact of a ruling issued by the IRS (with an identical DOL ruling) in September of 2013 that, for most employers, makes impractical the reimbursement of individual health policies.  

This article tries to outline what the position of the agencies are, the underlying law that resulted in these rulings, plans that do and do not run afoul of these rules and how to deal with a client that has been operating in ignorance of these rules and running an impermissible arrangement.

The September 2013 Notices

In Notice 2013-54 ( and Department of Labor Technical Release 2013-03 ( the IRS and DOL described issues that arise regarding rules applicable under the Affordable Care Act.  A further clarification of issues related to this notice was published in November of 2014 by the post of a set of frequently asked questions to the Department of Labor web site.

Two problem areas arise for self-insured HRAs under the “market reform” provisions of the ACA.  

First, those provisions require non-grandfathered employer plans to remove lifetime and annual limits on benefits to employees.  Second, the plans must provide, at no cost, certain preventative services.  If an HRA is forced to meet these requirements the program would become prohibitively risky for most employers.

The Notice, adopting guidance previously provided in the form of FAQs issued by the IRS, HHS and DOL, provides the following HRAs are exempted from meeting these requirements:

  • An HRA that covers fewer than two current employees (this is a statutory exemption)
  • An HRA that offers only exempted benefits (that is, no coverage of essential medical benefits)
  • An HRA that is integrated with employer offered group coverage that provides minimum value
    • Only employees who either participate in the group plan or have equivalent coverage (such as coverage under a spouse’s employer plan) may participate in the HRA
    • The employee must have the right, at least annually, to permanently opt out of and waive future benefits under the program
    • The HRA may not be “integrated” with individual health plans (such as would be the case with a plan designed around Revenue Ruling 61-146) 

The problems faced with employer reimbursement of employee’s individuals premiums is outlined specifically in Question 1 of the Notice which reads as follows:

Question 1: The HRA FAQs provide that an employer-sponsored HRA cannot be integrated with individual market coverage, and, therefore, an HRA used to purchase coverage on the individual market will fail to comply with the annual dollar limit prohibition. May other types of group health plans used to purchase coverage on the individual market be integrated with that individual market coverage for purposes of the annual dollar limit prohibition?

Answer 1: No. A group health plan, including an HRA, used to purchase coverage on the individual market is not integrated with that individual market coverage for purposes of the annual dollar limit prohibition.

For example, a group health plan, such as an employer payment plan, that reimburses employees for an employee's substantiated individual insurance policy premiums must satisfy the market reforms for group health plans. However the employer payment plan will fail to comply with the annual dollar limit prohibition because (1) an employer payment plan is considered to impose an annual limit up to the cost of the individual market coverage purchased through the arrangement, and (2) an employer payment plan cannot be integrated with any individual health insurance policy purchased under the arrangement.

The notice also discusses flexible spending arrangements (FSAs).  While noting that the FAQs originally stated that FSAs would be exempted from the market reform rules (the limits on benefits and the preventive care mandate), the notice clarifies that this was intended solely for FSAs that are part of a §125 cafeteria plan.

Question 8 of the Notice states:

Question 8: The interim final regulations regarding the annual dollar limit prohibition contain an exemption for health FSAs (as defined in Code § 106(c)(2)). See 26 C.F.R. §54.9815-2711T(a)(2)(ii), 29 C.F.R. §2590.715-2711(a)(2)(ii), and 45 C.F.R. §147.126(a)(2)(ii). Does this exemption apply to a health FSA that is not offered through a Code § 125 plan? 

Answer 8: No. The Departments intended for this exemption from the annual dollar limit prohibition to apply only to a health FSA that is offered through a Code § 125 plan and thus subject to a separate annual limitation under Code § 125(i). There is no similar limitation on a health FSA that is not part of a Code § 125 plan, and thus no basis to imply that it is not subject to the annual dollar limit prohibition. 

To clarify this issue, the Departments intend to amend the annual dollar limit prohibition regulations to conform to this Q&A 8 retroactively applicable as of September 13, 2013. As a result, a health FSA that is not offered through a Code § 125 plan is subject to the annual dollar limit prohibition and will fail to comply with the annual dollar limit prohibition.

Effectively, this ruling makes the use of Revenue Ruling 61-146 impractical (assuming an employer truly does not want to offer absolutely unlimited reimbursement of all medical costs for everyone) programs where the employer pays for employee’s individual policies.  Employers who have used such programs will either need to stop reimbursing such payments.

DOL’s November 2014 FAQ Update

In November of 2014 the Department of Labor issued further clarification on this provision.  The first question dealt with the Department’s view regarding a method that had been used to attempt to continue to provide such coverage.

Some commentators had suggested that the issue could be solved by having an employer simply make a reimbursement payment and include the amount in the employee’s W-2.  The FAQ makes clear that merely labeling the payment “after tax” will not solve the issue.

The FAQ provides:

Q1: My employer offers employees cash to reimburse the purchase of an individual market policy. Does this arrangement comply with the market reforms?

No. If the employer uses an arrangement that provides cash reimbursement for the purchase of an individual market policy, the employer's payment arrangement is part of a plan, fund, or other arrangement established or maintained for the purpose of providing medical care to employees, without regard to whether the employer treats the money as pre­tax or post­tax to the employee. Therefore, the arrangement is group health plan coverage within the meaning of Code section 9832(a), Employee Retirement Income Security Act (ERISA) section 733(a) and PHS Act section 2791(a), and is subject to the market reform provisions of the Affordable Care Act applicable to group health plans. Such employer health care arrangements cannot be integrated with individual market policies to satisfy the market reforms and, therefore, will violate PHS Act sections 2711 and 2713, among other provisions, which can trigger penalties such as excise taxes under section 4980D of the Code. Under the Departments' prior published guidance, the cash arrangement fails to comply with the market reforms because the cash payment cannot be integrated with an individual market policy.

Thus, continuing to do the same reimbursement as before but simply including it in the employee’s W-2 is not sufficient.  As well, any linkage between the pay for employee and that employee obtaining medical insurance coverage is likely to be seen by the DOL as an impermissible health plan due to the inability to integrate the pay with a market policy.

The key item to note is that the penalty under §4980D is (and always has been) a penalty tax on an impermissible health plan of an employer, not a penalty tax only on pre-tax health plans.

The FAQ also goes on to note two other “impermissible” structures with regard to an employer health plan.

First, it finds that an employer who offers high risk employees a choice between enrollment in its standard plan or cash is also in violation of the rules governing health plans.

That FAQ provides:

Q2: My employer offers employees with high claims risk a choice between enrollment in its standard group health plan or cash. Does this comply with the market reforms?

No. PHS Act section 2705,(7) which was incorporated by reference into ERISA section 715 and Code section 9815, as well as the nondiscrimination provisions of ERISA section 702 and Code section 9802 originally added by the Health Insurance Portability and Accountability Act (HIPAA), prohibit discrimination based on one or more health factors. Offering, only to employees with a high claims risk, a choice between enrollment in the standard group health plan or cash, constitutes such discrimination. While the Departments' regulations implementing this provision(8) permit more favorable rules for eligibility or reduced premiums or contributions based on an adverse health factor (sometimes referred to as benign discrimination), in the Departments' view, cash­or­coverage arrangements offered only to employees with a high claims risk are not permissible benign discrimination. Accordingly, such arrangements will violate the nondiscrimination provisions, regardless of whether (1) the cash payment is treated by the employer as pre-­tax or post-­tax to the employee, (2) the employer is involved in the selection or purchase of any individual market product, or (3) the employee obtains any individual health insurance.

Such offers fail to qualify as benign discrimination for two reasons. First, if an employer offers a choice of additional cash or enrollment in the employer's plan to a high­ claims­ risk employee, the opt­ out offer does not reduce the amount charged to the employee with the adverse health factor. Rather, the employer's offer of cash to a high ­claims­ risk employee who opts out of the employer's plan effectively increases the premium or contribution the employer's plan requires the employee to pay for coverage under the plan because, unlike other similarly situated individuals, the high­ claims­ risk employee must accept the cost of forgoing the cash in order to elect plan coverage. For example, if the employer's group health plan requires all employees to pay $2,500 toward the cost of employee ­only coverage under the plan, but the employer offers a high­ claims­ risk employee $10,000 in additional compensation if the employee declines the coverage, for purposes of discrimination analysis, the effective required contribution by that high­ claims ­risk employee for plan coverage is $12,500 – that is, the $2,500 required employee contribution for employee­ only coverage under the employer's plan plus the $10,000 of additional compensation that the employee would forgo by enrolling in the plan. Because a high­ claims­ risk employee must effectively contribute more to participate in the group health plan, the arrangement violates the rule that a group health plan may not on the basis of a health factor require any individual (as a condition of enrollment) to pay a premium or contribution which is greater than the premium or contribution for a similarly situated individual enrolled in the plan.

Second, the Departments' regulations generally permit providing, based on an adverse health factor, enhancements to eligibility for coverage under the plan itself but not cash as an alternative to the plan. In particular, the regulations permit providing plan eligibility criteria that offer extended coverage within the plan and subsidization of the cost of coverage within the plan based on an adverse health factor.(9) An example in the Departments' regulations illustrates that a plan may have an eligibility provision that provides coverage to disabled dependent children beyond the age at which non-disabled dependent children become ineligible for coverage. Another example in the regulations illustrates that a plan may provide coverage free of charge to disabled employees, while other employees pay a participant contribution towards coverage.(11) However, in the Departments' view, providing cash as an alternative to health coverage for individuals with adverse health factors is an eligibility rule that discourages participation in the group health plan. This type of arrangement differentiates based on a health factor and is outside the scope of the Departments' regulations on benign discrimination, which permit only discrimination that helps individuals with adverse health factors to participate in the health coverage being offered to other plan participants. The Departments intend to initiate rule-making in the near future to clarify the scope of the benign discrimination provisions.

Finally, because the choice between taxable cash and a tax-­favored qualified benefit (the election of coverage under the group health plan) is required to be a Code section 125 cafeteria plan, imposing an effective additional cost to elect coverage under the group health plan could, depending on the facts and circumstances, also result in discrimination in favor of highly compensated individuals in violation of the Code section 125 cafeteria plan nondiscrimination rules.

Finally, the FAQ looks at a plan being marketed to set up a §105 medical reimbursement plan that claim to allow employees to qualify for assistance and/or tax credits while having an employer provide a reimbursement.

That FAQ notes:

Q3: A vendor markets a product to employers claiming that employers can cancel their group policies, set up a Code section 105 reimbursement plan that works with health insurance brokers or agents to help employees select individual insurance policies, and allow eligible employees to access the premium tax credits for Marketplace coverage. Is this permissible?

No. The Departments have been informed that some vendors are marketing such products. However, these arrangements are problematic for several reasons. First, the arrangements described in this Q3 are themselves group health plans and, therefore, employees participating in such arrangements are ineligible for premium tax credits (or cost-­sharing reductions) for Marketplace coverage. The mere fact that the employer does not get involved with an employee's individual selection or purchase of an individual health insurance policy does not prevent the arrangement from being a group health plan. DOL guidance indicates that the existence of a group health plan is based on many facts and circumstances, including the employer's involvement in the overall scheme and the absence of an unfettered right by the employee to receive the employer contributions in cash.

Second, as explained in DOL Technical Release 2013­03, IRS Notice 2013­54, and the two IRS FAQs addressing employer health care arrangements referenced earlier, such arrangements are subject to the market reform provisions of the Affordable Care Act, including the PHS Act section 2711 prohibition on annual limits and the PHS Act 2713 requirement to provide certain preventive services without cost sharing. Such employer health care arrangements cannot be integrated with individual market policies to satisfy the market reforms and, therefore, will violate PHS Act sections 2711 and 2713, among other provisions, which can trigger penalties such as excise taxes under section 4980D of the Code.

Clearly, the Department of Labor is on the lookout for “workarounds” that attempt to use the individual market to provide an employee benefit.

Underlying Law

Clients and advisers may wonder where the provisions of the law the IRS and Department of Labor are addressing are found.  In reality, most of the provisions in question predate the Affordable Care Act.  What the ACA did was add requirements to the Public Health Services Act that are cross-referenced in the excise tax provision found at IRC §4980D.

IRC §4980D imposes a penalty of $100 per individual per day for a failure of the plan to meet the requirements found in Chapter 100 of the Internal Revenue Code.  Chapter 100 refers to IRC §§9801-9834.

Of key interest with regard to changes made by the Affordable Care Act is the incorporation under IRC §9815 of the provisions of the Public Health Services Act.     

PHSA §2711(a) specifically provides:

(a) Prohibition.

(1) In general. 

A group health plan and a health insurance issuer offering group or individual health insurance coverage may not establish—

(A) lifetime limits on the dollar value of benefits for any participant or beneficiary; or

(B) except as provided in paragraph (2), annual limits on the dollar value of benefits for any participant or beneficiary.

Similarly PHSA §2713 requires plans to provide certain preventive services without imposing any cost sharing arrangements.

However, IRC §9831(a)(2) provides that the requirements of Chapter 100 will not apply to any plan year if, as of the first day of the plan year, the plan has less than 2 participants who are current employees.  Therefore, for such plans the $100 a day penalty cannot be triggered by a failure to meet the market reform provisions of PHSA §2711 noted above.

An employer who owes the excise tax under §4980D must file Form 8928, “Return of Certain Excise Taxes Under Chapter 43 of the Internal Revenue Code” on or before the due date for filing the taxpayer’s income tax return. [Reg. §54-6071-1(b)]  An extension of the plan sponsor’s income tax return does not extend the time for filing the Form 8928.  Rather, the sponsor must file a separate Form 7004 to obtain a six month extension of time to file and must pay the tax due with the extension.  [Reg. §54.6081-1(b)]

As was described earlier, the IRS issued Notice 2013-54 that formalized guidance provided in January of 2013 in a FAQ.  That provided that the employer’s payment of health care premiums, among other things, would be treated as an HRA plan.  Since HRA plans are group health care plans, such plans providing only the payment of medical insurance premiums that are not exempted under IRC §9831(a)(2) would be required to have no annual or lifetime caps on most medical benefits.  As such plans, by their very nature, limit annual benefits to the cost of the insurance—creating a prohibited cap on benefits.  Similarly, since they have no provisions on their own to provide preventive care without cost to an employee, they are also in violation of this provision.

However, the January 2013 FAQ and Notice 2013-54 provided that such HRAs, if integrated with other coverage as part of a group health plan, would be exempted from meeting the cap rules if the other coverage would, by itself, comply with the dollar limit prohibition.  The same is true for the preventive care rules as long as the group insurance program has the proper preventive care provisions in it.

The employee must actually be enrolled in such other coverage for the integration rule to apply.

However, under no circumstances could an HRA be deemed integrated with individual market coverage or individual policies provided under an employer payment plan.

The Old (and Continuing in Force) Law

Under Revenue Procedure 61-146 an employer who reimburses an employee for premiums paid on an individual plan is allowed to exclude such payment from the employee’s compensation.  This ruling remains in force—but it is important to note it addresses provisions of the IRC other than §9815 and the related penalty under §4980D.

Similarly, IRS Notice 2008-1 provided, in Example 3, that an S corporation could reimburse the premiums paid on an individual policy for a shareholder-employee.  Such premiums would be treated as a plan providing medical care for the employee.  The payment would be included in Box 1 wages on Form W-2, but would not be either FICA, Medicare or FUTA wages for payroll tax purposes.  As well, assuming the shareholder-employee meets the other requirements (no ability to obtain coverage from another employer or the employer of the shareholder-employee’s spouse, etc.), the premiums would qualify for the self-employed health insurance deduction.

Again, this ruling remains in force but does not address issues raised by IRC §§9815 and 4980D.  

So, as a practical matter, these are not viable options for any program that covers more than one employee as of the start of the year.  Nevertheless, it’s important to note that ignoring the positive tax benefits of these rulings (that is, putting the amount in taxable income, subjecting the payments to payroll taxes and deducting any premiums paid on Schedule A) does nothing to avoid a violation, per Notice 2013-53, of IRC §9815 and, therefore, a potential liability for the $100 per individual per day penalty under IRC §4980D. (See the discussion of the November 2014 Department of Labor FAQ).


While paying for coverage and ignoring the tax benefits is not a valid strategy, there is nothing preventing an employer from simply eliminating the benefit and increasing the cash compensation of affected employees.  The employee may decide to use such funds to buy coverage—perhaps even the same coverage that the employer was previously reimbursing.  But the employer must not link the increased wages with the employee actually obtaining such coverage.

This option has a couple of disadvantages.  First, there will be a payroll tax cost that did not exist under the reimbursement approaches.  Second, the employee will have his/her adjusted gross income increased by the premium, which can have various negative impacts on the individual’s tax return due to the myriad of phase-outs in the tax law tied to adjusted gross income.  Third, the employee will only be able to get a tax benefit for a deduction of the premiums if the employee itemizes deductions and has enough medical expenses (including the insurance premiums) to clear the 10% (7.5% if over age 65) of adjusted gross income limits.

The other alternative is for the employer to obtain a group policy either via the standard group health market or via the SHOP exchange.  In this case the income and payroll tax advantages of the older reimbursement system are maintained.  However doing this will likely necessitate a change in coverage for the affected employees (with the potentially adverse consequences that can come from such a change) and may also result in higher premiums than would be due under individual policies.

Damage Control

What is to be done if an adviser discovers a client has maintained a noncompliant program during the year?  The adviser will need to look to the relief provisions of IRC §4980D(c) along with getting the client to terminate the noncompliant program as soon as possible.

Relief from the penalty may be granted in each of the following circumstances so long as the problem is discovered and corrected before a notice of income tax examination is received.  

  • The taxpayer establishes the failure is due to the fact that the taxpayer did not know of the failure and, exercising reasonable diligence, would not have known of the failure [IRC §4980(c)(1)] or
  • The failure is due to reasonable cause and not willful neglect and
    • For a church plan, the failure is corrected within a correction period similar to the correction period under §414(e)(4)(C) (basically 270 days after a final determination the plan is out of compliance) [IRC §4980(c)(2)]
    • For a plan other than a church plan, the failure is corrected within 30 days of the date the person knew or exercising reasonable due diligence should have known, the failure existed

If a notice of examination has been issued before the problem is corrected, a minimum penalty of the lesser of $2,500 or the regular penalty without regard to those two exceptions will be imposed.  If the violation is more than de minimis, the dollar amount penalty rises to $15,000. [IRC §4980D(b)(3)]  However, church plans are exempted from these minimum penalty rules. [IRC §4980D(b)(3)(C)]  

There are two other relief options available to programs as well.  These are detailed below:

  •  For a single employer plan where the failure is due to reasonable cause and not willful neglect, the penalty is limited to no more than the lesser of
    • 10% of the amount paid by employer for group health plans or 
    • $500,000
  •  For a multiple employer plan the above limit is applied by substituting the amount paid by the employer to the trust for the amount paid for group health plans [IRC §4980(c)(3)]

Finally, the IRS is granted the discretionary right to waive the penalty if the failure is due to reasonable cause and not willful neglect to the extent the IRS determines the payment of the tax would be excessive relative to the failure involved. [IRC §4980(c)(4)]

One key issue to recognize is that all of these relief options only apply if a failure is due to reasonable cause and either the employer was unaware of the requirement even though the employer exercised reasonable diligence or the failure was not due to willful neglect.  As such, once an employer becomes aware of the issue, the options for relief will disappear unless the employer corrects the problem.

Therefore, advisers must strongly discourage clients from deciding they are just going to keep doing what they are doing because they don’t want to change things.  While they may not like the available choices, they need to choose which acceptable option they wish to adopt and make sure the non-compliant program is terminated, preferably within 30 days of the discovery of the problem to insure an ability to argue for IRC §4980(c)(2) complete relief (assuming the reasonable cause/due diligence provisions can be met).

Form 8928 has provisions for disclosing the issue and the nature of the relief the taxpayer is asking for.   The relevant portion of the form is reproduced above.

The post was updated on January 14, 2015 to correct typos and add the relevant portion of Form 8928.