Overshadowed by the political drama surrounding the Affordable Care Act (ACA) is tax legislation enacted in December 2016 to make stand-alone health reimbursement arrangements (HRAs) available to employees of certain small employers. An HRA typically consists of an arrangement under which an employer makes nontaxable reimbursements of an employee’s medical expenses up to a predetermined annual maximum. The Internal Revenue Service (IRS) had interpreted the ACA to prohibit an employer from offering any HRA to its active employees unless the HRA was “integrated” with an employer’s group health plan complying with the ACA market reform requirements. That interpretation deterred employers without group health plans from maintaining stand-alone HRAs to reimburse their employees for the cost of health insurance the employees purchased for themselves in the individual insurance market. The new legislation, called the 21st Century Cures Act, has created a means for certain small employers to pay some of that cost on a tax-favored basis without tripping over the ACA restrictions on stand-alone HRAs.
The new legislation added Section 9831(d) to the Internal Revenue Code of 1986 (Code) effective generally for years beginning after December 31, 2016. Section 9831(d) refers to the new type of HRA as a “qualified small employer health reimbursement arrangement” (QSEHRA). A QSEHRA must meet the specific conditions described below.
The employer maintaining a QSEHRA must be one that is not an “applicable large employer” for purposes of the ACA employer mandate and does not offer a group health plan to any of its employees. An “applicable large employer” is defined in Section 4980H(c)(2) of the Code, with respect to a calendar year, as an employer that employs an average of at least 50 full-time employees, including full-time equivalent employees, on business days during the preceding calendar year. Thus, a QSEHRA is restricted to an employer with fewer than 50 full-time employees, as determined under Section 4980H of the Code and its regulations, including its rules treating affiliated employers as a single employer under Section 414(b), (c), (m), or (o) of the Code.
A QSEHRA must be funded solely by the employer with no salary reduction contributions by employees. Upon an employee’s proof of coverage, the arrangement provides for the payment or reimbursement of the employee’s medical care (as defined in Section 213(d) of the Code) incurred by the employee or the employee’s family members and substantiated. The maximum amount of payments and reimbursements for any year cannot exceed $4,950—or $10,000 in the case of an arrangement that also provides for payments or reimbursements for family members of the employee. These dollar maximums are adjusted annually for inflation and prorated for coverage periods of less than a year.
A QSEHRA must be provided on the same terms to all eligible employees of the employer. All employees of the employer must be eligible with the exception of the following (who may be excluded): employees who have not completed 90 days of service, employees who have not attained age 25, part-time or seasonal employees, employees covered by a collective bargaining agreement if health benefits were the subject of good faith bargaining, and nonresident aliens with no earned income from sources within the United States. An arrangement does not fail to meet this “same terms” requirement merely because the employee’s maximum benefit under the arrangement varies in accordance with the price of an insurance policy based on the number of family members the employee has covered under the arrangement and their ages.
Finally, an employer funding a QSEHRA for any year must provide a written notice to each eligible employee including prescribed information not later than 90 days before the beginning of the year, or in the case of an employee who is not eligible to participate in the arrangement as of the beginning of the year, the date on which the employee is first so eligible. The prescribed information includes (i) a statement of the amount which would be the eligible employee’s maximum benefit available under the employer’s QSEHRA for the year, not to exceed the dollar amounts described above, (ii) a statement that the employee should provide the information described in clause (i) to any health insurance exchange to which the employee applies for advance payment of the premium assistance tax credit, and (iii) a statement that if the employee is not covered under minimum essential coverage for any month, the employee may be subject to tax under Section 5000A of the Code for that month and reimbursements under the QSEHRA may be includible in gross income. New Section 6652(o) of the Code subjects the failure to provide this notice to a penalty of $50 per employee per failure, not to exceed $2,500 for all such failures during any calendar year. In addition, the employer is required to report the QSEHRA benefit on an eligible employee’s Form W-2.
The IRS responded to the QSEHRA notice requirement with transition relief in Notice 2017-20. According to that Notice, an employer that provides a QSEHRA to its eligible employees for a year beginning in 2017 is not required to furnish the initial written notice to those employees until after further guidance has been issued by the IRS. That further guidance will specify a deadline for providing the initial written notice that is no earlier than 90 days following the issuance of that guidance. No Section 6652(o) penalties will be imposed for failure to provide the initial written notice before the extended deadline specified in that guidance. It remains to be seen whether further guidance will include a model notice.
The new legislation exempts a QSEHRA from the mandates of the Employee Retirement Income Security Act of 1974 (ERISA) and the Public Health Service Act (PHSA) on group health plans, including the ERISA and PHSA mandates for COBRA continuation coverage. Similarly, a QSEHRA is not treated as a group health plan for purposes of the Code other than the “Cadillac” tax provisions of Section 4980I. However, the new legislation does not exempt a QSEHRA from the privacy and security requirements of the Health Insurance Portability and Accountability Act of 1996. Nor does it exempt a QSEHRA from the ERISA requirements applicable to an employee welfare benefit plan other than the group health plan requirements.
A small employer that does not offer its employees a group health plan now can offer them a QSEHRA to assist them on a tax-favored basis with paying their individual health insurance premiums, but the employer must be prepared to follow all the QSEHRA rules.
If you have any questions about QSEHRAs, please contact one of us or any of the other Tax lawyers at Thompson & Knight.