June 1, 2015 by Tony Novak
Get ready for 4980D small business excise tax penalties
In 30 days a significant new excise tax takes effect for many small businesses that reimburse employee health care expenses. Tens of thousands of small business employers are likely affected and many may still be unaware of the new tax. This article is written in non-technical language without references in an attempt to explain the tax law in plain language. The “Other publications” section includes articles with legal references.
The Affordable Care Act passed in 2010 includes Internal Revenue Code Section 4980D that adds an excise tax penalty against employers that reimburse employee health care expenses in a non-permitted manner. The original effective date of provision of the law was January 1, 2014. Large employers are already subject to the penalty provision. IRS issued various clarifications over the past two years and then offered an delay in enforcement of tax penalties for small business employers until June 30, 2015. Despite the clarifications and extension, IRS is aware that many small firms are in violation of this section of the tax code.
Amount of Penalty
The penalty is $100 per employee per day of violation which works out to $36,500 per employee for businesses with an ongoing violation. Obviously few small businesses could endure this amount of additional tax penalty. The law includes an alternate lower penalty for non-intentional violations in an amount of 10% of the employer payment. Yet the cost of professional representation to prove that the lower penalty is appropriate might significantly increase the cost of this violation.
Method of tax penalty application
The tax penalty should be self-assessed at the time the 2015 tax return is prepared. In most cases we presume that this means that the 2015 business income tax return would be prepared in early 2016. In this scenario the first tax penalty for an employer with an ongoing non-qualified health expense reimbursement program would be assessed for six months: July 1, 2015 to December 31, 2015. The presumed initial tax penalty would be $18,250 per employee.
Presumably the lower penalty cannot be self-addressed (it is tough to argue “unintentional violation” if you admit that you know about the law in the tax return preparation) but must be argued in response to an audit. The assessment and appeal process possibilities are not discussed in this article.
We might also presume that some tax preparers would be reluctant to self-assess and thereby increase their business client’s next tax assessment calculation by an amount of $18,250 per employee per year. This might be especially true if the tax preparer is also viewed as a tax adviser who did not provide appropriate advance warning of the new tax penalty. This article does not address potential tax preparer liability with regard to IRC 4980D excise tax penalties.
An employer may reimburse employee health care expenses if the reimbursement plan meets the requirements of and the reimbursement is limited to employees who are covered under an employer-provided ACA-compliant group health insurance plan. Specifically, employees covered by another employer’s health insurance (e.g. spousal coverage) or (except in limited circumstances where group insurance is not appropriate) employees covered by individual health insurance.
Permitted reimbursements under a properly documented and administered reimbursement plan include:
- Deductibles, co-payments and out-of-pocket expenses listed in IRS Publication 502
- Long term care insurance
- Exempted insurance including supplemental insurance
The following list is provided to indicate some non-exhaustive examples of non-permitted reimbursements that presumable would trigger the 4980D excise tax penalty:
- Reimbursements without a written plan
- Reimbursements not substantiated or not allowed within the employer plan
- Reimbursements for individual health insurance
- Reimbursements for employees or dependents not covered by the employer’s group health insurance plan.
- Reimbursements for expenses covered by other insurance or benefit plans
How to avoid penalties
Avoiding tax penalties appears straightforward. Before June 30, 2015 employers should take two steps:
- Amend reimbursement plan documents to comply with current law
- Adjust payroll taxes retroactively to reflect the correct tax treatment of prior health care reimbursements
As a practical matter, it seems likely that small business employers making this change for tax compliance reasons would seek an alternative qualified reimbursement arrangement to “soften the blow” of this severe change in their employee benefit plans. I wrote an article suggesting one idea here.
Freedom Benefits web site
Year-End Tax Moves for Small Businesses – Wall Street Journal 11/21/2014