August 30, 2014 by Tony Novak
Editorial note: IRS Notice 2013-54 clarified many of the issues in this blog post. This post was updated several times, including to correct an error in the original post.
Questions about employer payments for individual health insurance continue to be the most frequent topic fielded through my OnlineNavigator advisory service that addresses questions related to the Affordable Care Act. This question from a small church hits on many of the important issues to consider when planning for a health plan for 2015. (Small church planning is the same as small business planning in this regard).
“Q: We are a church with 2 employees, one Medicare eligible by December 2014 and one not medicare eligible. We have a small group insurance currently. Our group insurance renews in 20 days and we have to decide if we do that or not. Our premiums are pretty high and the church would save money if one elects the medicare option and the other gets an individual insurance. However, the church don’t want the employees (pastors actually) to be encumbered with extra tax payments or personal out of pocket medical costs.
Very interested about how you explained the HRA and wondering if this is the best option for us. Could you give us some advice?”
“A: Thanks for writing. Yes, I’ve helped set up many HRA plans for small churches. Your observations are typical for what other small churches and businesses are experiencing now.
In your planning, please consider that it is the type of insurance and not the use of the HRA that determine the tax status of the transaction:
– If the church is reimbursing through the HRA or directly paying the cost of group health insurance, mini-med or supplemental health insurance then the transaction amount is tax-free to the employees.
– If the church is reimbursing through the HRA or paying directly the cost of individual qualified major medical insurance (as available through an exchange) paid by the church then it is still tax-free to the employee but may trigger an excise tax to be paid by the employer.
Additionally, you may wish to consider whether the insurance company will continue to offer group insurance to a one member group. In many parts of the country the health insurance companies are terminating these one person plans as allowed.
The HRA is most useful when used in conjunction with a qualified health plan for helping reduce taxes for medical expenses not covered by insurance, since today’s insurance policies tend to have hefty deductibles, co-payments and excluded charges. The type of HRA plan used for this purpose is now called a “special purpose” to distinguish from the plans prior to 2014 when the applicable tax law changed. The limited purpose HRA allows you to avoid income tax on payments for these expenses. If you wish to proceed with the HRA I am happy to help.
I expect this will continue to be a ‘hot issue’ for small businesses in the months to come. IMO, the three key points that many are small employers are missing in their health care planning is that:
1) In many cases the member’s out-of-pocket costs not covered by an insurance policy are at least as large as the insurance premiums so it makes sense to make this a higher priority in the planning process. It makes no sense to only focus on deductibility of the insurance premiums and ignore the net after-tax cost of the entire health care picture.
2) In most cases the net cost, even after paying the income taxes, is lower using individual insurance rather than group insurance. Even if this is not true initially, it may be true later because small group insurance rates will increase faster than large group and individual insurance rates.
3) An health insurance company will usually not accept a premium payment from a business for an individual health insurance policy. The insurer will usually return the business check and request an individual check or request that electronic payment be made from an individual account. To do otherwise would expose the insurance company to the compliance risks under federal ERISA law and so insurance companies will not knowingly accept this risk.