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Alert: Reimbursing Employee Health Insurance? The Old Tax Rules Don’t Apply

Some small employers, including dentists, are likely due for an unwelcome surprise this year when it comes to how they’ve handled health insurance plans and/or reimbursement for themselves and their employees.
Under the new Affordable Care Act, regulations related to health insurance have changed. While small businesses (with fewer than 50 employees) are not required to provide health coverage for their workers, other parts of the ACA do apply to them—such as if they pay for individual health insurance policies, as opposed to a group policy.

The first thing that’s important to know is how ACA regulations pertain to your practice’s structure (sole proprietor, partnership, C-Corporation, S-Corporation, etc.) Your financial advisor can tell you how the ACA affects your ability to deduct your practice’s health insurance premiums. Prior to the ACA, employers could deduct expenses for individual health insurance plans for their employees and themselves. Pre-tax reimbursements made to employees for health coverage they received through other means (a spouse, for example) were also deductible, and served as a tax-free benefit to the employee.

Not anymore. With the ACA, both the deduction for the employer and the tax-free benefit to the employee for individual policies are gone.

In fact, if you have been paying for individual premiums during 2014 there is a $100 per day, per employee, penalty for being out of compliance.

In other words, to help pay for the health coverage expansion under the ACA, employers can no longer use payment plans to reimburse employees on a pre-tax basis for health insurance premiums that employees pay on an individual policy (either through a qualified health plan in or outside of the healthcare marketplace).

However, there’s an exception:  If your practice established a formal IRS Code Section 105 Medical Reimbursement Plan in or before 2014 (otherwise known as a Health Reimbursement Arrangement or Health Reimbursement Account), then money used to reimburse employees through the plan is not considered taxable income to them. So you can exclude the payments from wages subject to taxes, and you can deduct them as a business expense.

Otherwise, though, small employers under the ACA will be paying more for their own health insurance coverage in 2014, and reimbursements made to employees for their health insurance premiums will have to be counted as wages on which employees will pay taxes. If you don’t account for those reimbursements as wages, you could be subject to penalties in 2014 under the new ACA regulations (as mentioned above). It’s best to consult with your financial or tax advisor about the steps you may need to take now to avoid those penalties.

He or she can also help you explore ways to lessen the expense to your practice in the future through such tax planning opportunities as a Code Section 105 Medical Reimbursement Plan, a premium-only plan, or health savings accounts.

For example, one way to mitigate the costs next year for employee health insurance can be by raising an employee’s wages in lieu of the reimbursements you were making in the past.  If you, as the employer, gave your employees each a $300 per month raise to help offset the cost of health insurance, that also serves as a payroll cost that allows for deductions.  Your employees could go to the health marketplace and purchase a plan that costs $300 a month. Depending on individual annual income level, they might qualify for a subsidy that could pay as much as $200 of that $300 amount.  With that subsidy, the out-of-pocket expense for a qualifying employee for health insurance would then be $100 per month and he or she realizes a $200 per month boost to the household budget. That’s a best-case scenario that benefits both employer and employee.

While there’s not much, if anything, you can do now to lessen the tax burden for your employees or yourself in 2014, there’s also good news. You can likely avoid paying any penalties under the ACA if you take the right steps before the end of the year. Plus, there are ways to limit your practice’s health care expenses in the future.

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