On March 23, 2010, President Obama signed comprehensive health care reform into law. The Patient Protection and Affordable Care Act amends in significant ways the IRC, ERISA, and the Public Health Service Act. The law, known as the PPACA, ACA, and Affordable Care Act, focuses on expanding health care coverage, controlling health care costs, and improving the health care delivery system. It attempts to accomplish these goals in a variety of ways, as will be further described in Q 427 to Q 476.

The health care reform law is, in many ways, a broad outline, the details of which have been filled in by regulators over the years. Regulations continue to be released by the Department of Labor, the Treasury Department, and the Department of Health & Human Services. The ACA has survived several constitutional challenges, yet as of the date of this publication, continues to face various legal challenges.

The ACA went into effect between 2010 and 2018. The bulk of the provisions became effective beginning in 2011 through 2014. The effective date for the state health insurance exchanges was January 1, 2014. One provision, the controversial tax on high-cost (so-called “Cadillac”) health care plans, was originally scheduled to become effective in 2018, but this date was delayed first until 2020 and again until 2022. Late in 2019, the Cadillac tax was repealed entirely.

Health care reform covers insured and self-funded comprehensive medical health plans. In effect, the ACA governs major medical insurance and self-insured major medical plans.

Health care reform does not regulate excepted benefits, which include standalone vision, standalone dental, cancer, long-term care insurance, Medigap insurance, certain flexible spending accounts (“FSAs”), and accident and disability insurance that make payments directly to individuals. However, it did impose an annual contribution limit of $2,500 per year on health FSAs ($3,200 in 2024, $3,050 in 2023, $2,850 in 2022, $2,750 in 2020-2021, $2,700 in 2019 – the amount is indexed annually for inflation).

The ACA also does not affect retiree-only plans. Although it removed the exemption for retiree-only plans and excepted benefit plans from the PHS Act, it left those exemptions in the IRC and ERISA. The preamble and footnote two of interim final grandfathered plan regulations explain that the exemption for retiree-only plans and excepted benefit plans still applies for those plans subject to the IRC and ERISA.

With respect to retiree-only and other excepted benefit plans, federal regulators have decided that even though those provisions were removed by the ACA, they will interpret the PHS Act as if an exemption for retiree-only and excepted benefit plans was still in effect. Federal regulators have encouraged state insurance regulators to do the same, although in any given state, it is possible, although extremely unlikely, that regulators will decide to enforce the ACA mandates on all fully insured plans, including those that are excepted benefit plans.

A credit is available for employee health insurance expenses of an eligible small employer for taxable years beginning after December 31, 2009, provided the employer offers health insurance to its employees.¹

An eligible small employer is an employer that has no more than 25 full time employees, the average annual wages of whom do not exceed $50,000 (in 2010-2013; the amount is indexed to $50,800 in 2014, $51,600 in 2015, $51,800 in 2016, $52,400 in 2017, $53,200 in 2018, $54,200 in 2019, $55,200 in 2020, $55,600 in 2021, $57,400 in 2022 and $61,400 in 2023).²

An employer must have a contribution arrangement for each employee who enrolls in the health plan offered by the employer through an exchange that requires that the employer make a non-elective contribution in an amount equal to a uniform percentage, not less than 50 percent, of the premium cost.³

Subject to phase-out⁴ based on the number of employees and average wages, the amount of the credit is equal to 50 percent, and 35 percent in the case of tax exempts, of the lesser of (1) the aggregate amount of non-elective contributions made by the employer on behalf of its employees for health insurance premiums for health plans offered by the employer to employees through an exchange, or (2) the aggregate amount of non-elective contributions the employer would have made if each employee had been enrolled in a health plan that had a premium equal to the average premium for the small group market in the ratings area.⁵

For years 2010, 2011, 2012, and 2013, the following modifications applied in determining the amount of the credit:

(1)     the credit percentage is reduced to 35 percent (25 percent in the case of tax exempts);⁶

(2)     the amount under (1) is determined by reference to non-elective contributions for premiums paid for health insurance, and there is no exchange requirement;⁷ and

(3)     the amount under (2) is determined by the average premium for the state small group market.⁸

The credit also is allowed against the alternative minimum tax.⁹

In 2014, small employers gained exclusive access to an expanded Small Business Healthcare Tax Credit under the Affordable Care Act. This tax credit covers as much as 50 percent of the employer contribution toward premium costs for eligible employers who have low- to moderate-wage workers.

1.    IRC § 45R, as added by PPACA 2010.

2.    IRC §§ 45R(d), as added by PPACA 2010; IRC § 45R(d)(3)(B), as amended by Section 10105(e)(1) of PPACA 2010, Rev. Proc. 2018-18, Rev. Proc. 2018-57, Rev. Proc. 2019-44, Rev. Proc. 2020-45.

3.    IRC § 45R(d)(4), as added by PPACA 2010.

4.    IRC § 45R(c), as added by PPACA 2010.

5.    IRC § 45R(b), as added by PPACA 2010.

6.    IRC § 45R(g)(2)(A), as added by PPACA 2010.

7.    IRC §§ 45R(g)(2)(B), 45R(g)(3), as added by PPACA 2010.

8.    IRC § 45R(g)(2)(C), as added by PPACA 2010.

9.    IRC § 38(c)(4)(B), as amended by PPACA 2010. The IRS has issued guidance; see Notice 2010-44, 2010-22 IRB 717; Notice 2010-82, 2010-51 IRB 1.

The tax credit (Q 430) applies to for-profit and non-profit employers meeting certain requirements. From 2010 through 2013, the amount of the credit for for-profit employers is 35 percent (25 percent for non-profit employers) of qualifying health insurance costs. The credit is increased for any two consecutive years beginning in 2014 to 50 percent of a for-profit employer’s qualifying expenses and 35 percent for non-profit employers.

Planning Point: The credit is not terribly useful, as the practitioner’s cost to calculate it is often near the value of the credit.

The health insurance tax credit is designed to help approximately four million small for-profit businesses and tax-exempt organizations that primarily employ low and moderate-income workers. The credit is available to employers that have 24 or fewer eligible full time equivalent (“FTE”) employees, excluding owners and their family members, paying wages averaging under $50,000 per employee per year (as indexed, $51,600 in 2015, $51,800 in 2016, $52,400 in 2017, $53,400 in 2018, $54,200 in 2019, $55,200 in 2020, $55,600 in 2021, $57,400 in 2022 and $61,400 in 2023).

IRC Section 45R provides a tax credit beginning in 2010 for a business with 24 or fewer eligible FTEs. Eligible employees do not include seasonal workers who work for an employer 120 days a year or fewer, owners, and owners’ family members, where average compensation for the eligible employees is less than $50,000 and where the business pays 50 percent or more of employee-only (single person) health insurance costs. Thus, owners and family members’ compensation is not counted in determining average compensation, and the health insurance cost for these people is not eligible for the health insurance tax credit.

The credit is largest if there are 10 or fewer employees and average wages do not exceed $25,000, in both cases excluding owners and their family members. The amount of the credit phases out for businesses with more than 10 eligible employees or average compensation of more than $25,000 and under $50,000. The amount of an employer’s premium payments that counts for purposes of the credit is capped by the average premium for the small group market in the employer’s geographic location, as determined by the Department of Health and Human Services.

Example: In 2023, a qualified employer has nine FTEs (excluding owners, owners’ family members, and seasonal employees) with average annual wages of $24,000 per FTE. The employer pays $75,000 in health care premiums for these employees, which does not exceed the average premium for the small group market in the employer’s state, and otherwise meets the requirements for the credit. The credit for 2023 equals $37,250 (50 percent x $75,000). Note that the credit in 2013 would have been $26,250 (35 percent x $75,000).¹

1.    Additional examples can be found online at http://www.irs.gov/pub/irs-utl/small_business_health_care_tax_credit_scenarios.pdf.

To obtain the credit, an employer must pay at least 50 percent of the cost of health care coverage for each counted worker with insurance.

In 2010, an employer qualified if it paid at least 50 percent of the cost of employee-only coverage, regardless of actual coverage elected by an employee. For example, if employee-only coverage costs $500 per month, family coverage costs $1,500 per month, and the employer pays at least $250 per month (50 percent of employee-only coverage) per covered employee, then even if an employee selected family coverage the employer would meet this contribution requirement to qualify for the tax credit in 2010.

Beginning in 2011, however, the percentage paid by an employer for each enrolled employee must be a uniform percentage for that coverage level. If an employee receives coverage that is more expensive than single coverage, such as family or self-plus-one coverage, an employer must pay at least 50 percent of the premium for each employee’s coverage in 2011 and thereafter.

Thus, grandfathered health insurance plans that provide, for instance, for 100 percent of family coverage for executives and employee-only coverage for staff will qualify for the tax credit in 2010 but not in 2011 or beyond.

Self-insured plans are subject to nondiscrimination rules for income tax purposes. The ACA imposed the same nondiscrimination rules that apply to self-insured plans to insured plans for plan years beginning on or after September 23, 2010. These health insurance nondiscrimination rules have been delayed, however, and do not apply at all to grandfathered health insurance plans as long as they remain grandfathered and have covered at least one participant continuously since March 23, 2010. These rules are intended to prevent discrimination in favor of higher paid employees in nongrandfathered health insurance plans.

IRS Notice 2011-1 delayed the application of the nondiscrimination rules for insured health plans that are not grandfathered from the first plan year beginning on or after September 23, 2010, until a date that will be specified after regulations on these rules are issued. As of this writing, no regulations have been proposed and informal discussions with Treasury personnel indicate that they may not be issued in the near future.

ACA Sections 1001 and 1562(e)-(f) add ERISA Section 715 and IRC Section 9815, respectively. Both ERISA Section 715 and IRC Section 9815 incorporate by reference Section 2716 of the Public Health Service Act (“PHSA”), a section that applies to employer health insurance plans. PHSA Section 2716 incorporates by reference the concepts of IRC Section 105(h), which applies to self-funded health plans, and applies those nondiscrimination rules to insured group health plans. Regulations will determine the exact definition of nondiscrimination.

To satisfy nondiscrimination eligibility classifications when required to do so under regulations yet to be issued by the IRS, the regulations for insured health plans will likely be based on the rules for self-insured plans, where a plan must:

(1)     benefit 70 percent or more of all employees;

(2)     benefit 80 percent or more of all eligible employees if 70 percent or more of all employees are eligible for benefits under the plan; or

(3)     benefit employees who qualify under an employer’s classification scheme that the IRS determines to be nondiscriminatory.

Excludable Employees

For purposes of the foregoing percentage tests, employees are not counted if they meet any one or more of the following tests:

(1)     have been employed by an employer for fewer than three years;

(2)     are under 25 years old;

(3)     are employed part-time;

(4)     are included in a bargaining unit covered by a collective bargaining agreement where accident and health benefits were the subject of good faith bargaining; or

(5)     are nonresident aliens with no U.S. source earned income.

Part-time employees are (1) those whose customary weekly employment is fewer than 35 hours if other employees in similar work with the same employer or, if no employees of the employer are in similar work, in similar work in the same industry and location, have substantially more hours and (2) seasonal employees whose customary annual employment is fewer than nine months, if other employees in similar work with the same employer or, if no employees of the employer are in similar work, in similar work in the same industry and location, work substantially more months.

Any employee whose customary weekly employment is fewer than 25 hours or any employee whose customary annual employment is fewer than seven months also may be considered a part-time or seasonal employee.

Highly Compensated Individuals

Under IRC Section 105(h), a plan cannot discriminate in favor of highly compensated individuals as to their eligibility to participate and benefits provided under a plan cannot discriminate in favor of participants who are highly compensated individuals.

For purposes of these nondiscrimination rules, highly compensated individuals are:

(1)     individuals who are among the five most highly paid officers of a corporation;

(2)     any shareholder who owns, including through attribution of ownership by others, more than 10 percent in value of an employer corporation’s stock; or

(3)     individuals who are among the most highly paid 25 percent of all employees.

Planning Point: Items (1) and (2) above apply to corporations. Presumably the new regulations will also deal with LLCs, partnerships, and other forms of businesses.

The health insurance nondiscrimination rules, the effective date of which has been delayed until regulations have been released and a new effective date has been announced by the IRS, have different sanctions than self-insured plans that fall under IRC Section 105(h).

For discriminatory self-insured plans, highly compensated employees have taxable income based on the benefits paid by their employer. By contrast, with respect to the new health insurance nondiscrimination requirements, the sanction under IRC Section 4980D is a $100 per day excise tax on affected employees.

Although the IRS has not yet issued regulations on the penalty, its request for comments indicates that the term “affected employees” means those who are not highly compensated. Thus, if an employer has an insured health plan that is not grandfathered and that violates these new nondiscrimination rules for a plan year after these rules go into effect, and if that employer has 20 non-highly compensated employees, the penalty will be $2,000 per day as a result of having a discriminatory non-grandfathered health insurance plan.

IRC Section 4980(D)(d)(1) contains an exception to the excise tax for small employers, but the language is somewhat ambiguous. It states, “In the case of a group health plan of a small employer which provides health insurance coverage solely through a contract with a health insurance issuer, no tax shall be imposed by this section on the employer on any failure (other than a failure attributable to section 9811) which is solely because of the health insurance coverage offered by such issuer.” It is not clear whether this exception applies to the new nondiscrimination rules or simply to a health insurance policy that does not meet federal requirements. For the purpose of this exception, a small employer is defined as two to 50 employees.

There also is a 10 percent cap on the excise tax, that is, 10 percent of aggregate premiums paid by an employer, for inadvertent violations of the nondiscrimination rules.

Yes and no.

Although grandfathered health insurance plans are exempt from many requirements, they are not exempt from all health care reform requirements. Grandfathered plans will be exempt from the health insurance nondiscrimination rules when those are published. Grandfathered plans are subject to the following mandates:

(1)     Prohibition of lifetime benefit limits

(2)     No rescission except for fraud or intentional misrepresentation

(3)     Children, who are not eligible for employer-sponsored coverage, covered up to age 26 on a family policy, if the dependent does not have coverage available from his or her employer

(4)     Pre-existing condition exclusions for covered individuals younger than 19 are prohibited

(5)     Restricted annual limits for essential benefits

Grandfathered health plans are exempt from the following requirements that apply to new and non-grandfathered health plans:

(1)     No cost-sharing for preventive services

(2)     Nondiscrimination based on compensation

(3)     Children covered up to age 26 on family policy regardless of whether a policy is available at work. Grandfathered status for the adult dependent coverage ended on January 1, 2014

(4)     Internal appeal and external review processes

(5)     Emergency services at in-network cost-sharing level with no prior authorization

(6)     Parents must be allowed to select a pediatrician as a primary care physician for their children and women must be allowed to select an OB-GYN for their primary care physician

Self-funded plans generally are treated the same as insured plans under the ACA. Analysis of the application of the ACA to self-insured plans begins with Section 1562, which adds Section 715 to ERISA and Section 9815 to the IRC. These provisions state that all of the provisions of Part A of Title XXVII of the Public Health Service Act (“PHSA”), as amended by the ACA, apply to both ERISA group health plans and health insurance issuers that insure group health plans. ERISA group health plans include both self-insured and insured plans.

The section further provides that if anything in ERISA’s group plan requirements conflicts with Part A of the PHSA, the PHSA shall govern. The fact that this section refers both to group health plans and to insured group health plans makes it clear that the provision is meant to apply to self-insured plans. This is reinforced by subsection (b) of this section adding new Section 715 to ERISA and IRC Section 9815 to the IRC, both of which state that Section 2716 and Section 2718 of the PHSA do not apply to self-insured plans, suggesting that the remaining provisions do.

This analysis is strengthened by the definition of group health plan under ACA Section 1301(b)(3), which incorporates the definition of Section 2791 of the PHSA, defining group health plan to mean an employee welfare benefit plan as defined in ERISA Section 3(1). Section 1551 of the ACA also provides that the definitions of PHSA Section 2791 apply to the ACA.

Several sections of the ACA refer specifically to self-insured plans.

Section 2701(a)(5), applying the health status underwriting provisions to large group plans in an exchange, does not apply to self-insured plans. Section 2715 requires a plan sponsor or designated administrator to make disclosures required by that section for self-insured plans.

Section 2716, which addresses discrimination in favor of highly-compensated employees, expressly states that it does not apply to self-insured plans, which already are covered by a similar requirement under IRC Section 105(h).

Self-insured plans expressly are subject to the external review requirements, that is, the appeal requirements, of Section 2719 to be established by the Department of Health and Human Services (HHS).

The reinsurance provisions of Section 1341 expressly apply to self-insured plans; the risk-pooling provisions of Section 1343 expressly do not.

Self-insured plans expressly are subject to a per-member fee to fund patient centered outcomes research under recently added IRC Section 4376.

HHS has addressed amendments by the ACA to the law permitting self-funded nonfederal governmental plans to opt out of compliance with certain federal benefit mandates. Except for a narrow band of requirements, these group health plans will no longer be permitted to opt out of HIPAA rules regarding the preexisting condition exclusion and special enrollment. Plan sponsors may continue to opt out of requirements under the Newborns’ and Mothers’ Health Protection Act, Mental Health Parity and Addiction Equity Act, Women’s Health and Cancer Rights Act, and Michelle’s Law.

These changes are effective beginning on or after September 23, 2010, for non-collectively bargained self-funded nonfederal governmental plans. Self-insured nonfederal governmental plans maintained pursuant to a collective bargaining agreement ratified before March 23, 2010, and that have been exempted from any of the relevant HIPAA requirements (for example, limits on preexisting condition exclusions, special enrollment periods, and health status nondiscrimination requirements) will not have to come into compliance with those requirements until the first day of the first plan year following the expiration of the last plan year governed by a collective bargaining agreement.

Although all plans except grandfathered plans are subject to the new appeals rules, effective for plan years beginning after September 23, 2011, with limited exceptions, self-insured plans are most affected because compliance for insured plans is handled by the insurance company, not the plan sponsor.

There is no delayed effective date for collectively bargained plans, whether fully insured or self-insured. Thus, plans maintained pursuant to one or more collective bargaining agreements in effect on March 23, 2010, must comply with the new rules at the same time as other grandfathered plans, although with a few differences.

The interim final grandfather regulations provide that fully insured, but not self-insured, collectively bargained plans retain their grandfathered status until the expiration of the agreement in effect on March 23, 2010. Self-insured collectively bargained plans are subject to the rules in the same way as other covered health plans.

Thus, a change in carriers under a fully insured collectively bargained plan does not result in the loss of grandfathered status if the change is made before the expiration of the agreement in effect on March 23, 2010. Additionally, changes to benefits that apply while that collective bargaining agreement is in effect, including increasing co-payments, do not result in loss of grandfathered status.

Whether grandfathered status applies after expiration of a collective bargaining agreement is determined by comparing benefits in effect at that time to benefits in effect on March 23, 2010. If the changes are not within permitted parameters, then a plan will cease to be grandfathered when the relevant agreement expires.

The interim final rule for grandfathered plans makes two clarifications with respect to collectively bargained plans.

First, it confirms that both insured and self-funded collectively bargained plans that are grandfathered health plans are subject to the same coverage reform mandates under the ACA at the same time that its mandates are effective with respect to other grandfathered health plans. Therefore, collectively bargained plans must comply with the extension of dependent coverage mandate, the elimination of lifetime and annual dollar limits, and the prohibition on pre-existing condition exclusions at the same time that these mandates become effective for all other grandfathered health plans.

Second, a collectively bargained insured plan may maintain its grandfathered status beyond the termination of the last of the applicable collective bargaining agreements provided that any changes to the terms of coverage under the plan are not changes that would cause the plan to lose grandfathered status under the interim final rule. Thus, collectively bargained insured plans are treated the same as all other grandfathered health plans on the termination of the last of the applicable collective bargaining agreements in effect on March 23, 2010, so their grandfathered status may last indefinitely as well.

Regulations also provide that a collectively bargained plan may be amended early for some or all of the law’s rules. This voluntary amendment is not a termination of the collective bargaining agreement that otherwise might subject the plan to an earlier compliance deadline.

A grandfathered health plan is any group health plan or individual health insurance policy that was in effect on the date of the ACA’s enactment, March 23, 2010, and that has covered at least one person continuously. Even if an individual re-enrolls in a grandfathered health plan or new employees or their families are added to a plan after March 23, 2010, a plan’s grandfathered status continues. Interim final regulations provide that if any benefit is eliminated or employees’ cost is increased more than a minor amount, then grandfathered status is lost. In addition, the regulations require that to maintain a grandfathered status, the plan must give an annual notice to participants, advising them that the plan is grandfathered and the consequences.

Original regulations provided that if an insured non-collectively bargained plan changes insurance carriers, even if benefits are the same or greater, grandfathered status is lost. The HHS, IRS, and DOL later amended the regulations to provide that new group health insurance would not cause loss of grandfathered status if it was effective on or after November 15, 2010, if coverage is at least as good and costs are not increased more than allowed to retain grandfather status. The amendment to the regulations applies only to group health plans, not to individual health insurance.

This change, allowing a switch in insurance companies without losing grandfathered status, does not apply to changes in policies between June 14 and November 15, 2010. Changes in insurance carriers during that time still cause loss of grandfathered status. For this purpose, the date new coverage becomes effective is controlling, not the date the new insurance contract or policy is entered into. For changes to group health insurance coverage on or after March 23, 2010, but before June 14, 2010, the date the regulations were made publicly available, the agencies’ enforcement safe harbor remains in effect for good faith efforts to comply with a reasonable interpretation of the law.

For self-insured plans, a change in third party administrator, in and of itself, does not cause a group health plan to cease to be a grandfathered plan. Additionally, grandfathered status can be retained when a plan changes its structure from self-insured to insured or insured to self-insured.

Planning Point: An IRS representative has informally indicated that eliminating coverage for a group or segment of a workforce would not cause a plan to relinquish its grandfathered status. Eliminating coverage for a class of employees is not one of the changes prohibited by regulations.

Although most of the mandates in the ACA apply to both group health plans and group health insurance issuers, new Public Health Service Act (“PHSA”) Section 2716 applies only to insured group health plans. Accordingly, even if Section 2716 were interpreted to apply to future modifications to existing health benefit designs that are discriminatory in favor of highly compensated employees, there may be structures available to an employer whereby it can cause an insurer to issue a special individual policy, or to provide special individual coverage, to highly compensated individuals without the policy or arrangement being treated as part of a new non-grandfathered group health plan.

Where special individual benefits are provided to a group of highly compensated employees, however, they may be considered to be part of a group health plan.

As discussed in Q 439, multi-employer and single-employer collectively bargained health plans in effect on March 23, 2010 are not subject to the reform law until the date on which the last of the collective bargaining agreements relating to the coverage terminates. At that time, a collectively bargained plan then is subject to health care reform rules and, assuming that it remains grandfathered, based on the rules then in effect, it would have to comply with the requirements for grandfathered plans.

Teens and young adults, even if they are no longer dependents for income tax purposes and even if they are married, can stay on or be added to their parents’ health insurance plan until age 26, or through age 26 if a plan or policy allows. Young adults also are not required to live with their parents or, as noted above, to be financially dependent on them. This right to coverage applies to all types of plans that offer dependent coverage.

In grandfathered employer group plans, that is, policies that existed on March 23, 2010, and that have not changed substantially, children are not eligible to go on parents’ plans if the children have access to coverage through their own workplace.

In non-grandfathered plans, they are eligible to be covered on their parents’ policy even if they have coverage through work.

New rules prevent insurers from denying coverage to children under age 19 with pre-existing medical conditions including asthma or cancer for plan years beginning on or after September 23, 2010. Insurers may limit certain open enrollment periods when children are signed up; this does not apply to grandfathered individual plans.

Similar protections for adults with pre-existing medical conditions did not begin until 2014. In the interim, adults with medical conditions who have been uninsured for at least six months were able to purchase coverage through federal high-risk pools created by the health care reform law.

Section 9003 of the ACA adds IRC Section 106(f), which revises the definition of medical expenses for employer-provided accident and health plans, including health flexible spending arrangements (health FSAs) and health reimbursement arrangements (HRAs). Section 9003 also revises the definition of qualified medical expenses for health savings accounts and Archer medical savings accounts.

Prior to 2020, over-the-counter drugs were not eligible for reimbursement by these plans unless a physician issued a prescription. The requirement was removed in 2020. Prior to that, for example, if a physician were to prescribe aspirin, this expense could be reimbursed but the purchase of aspirin without a prescription could not be reimbursed.

Other changes in health FSAs and HRAs are discussed in the following Q&As.

For plan years beginning in 2011 and before 2020, no plan could provide for, or reimburse on a tax favored basis, non-prescription over-the-counter drugs. This prohibition applies to medical expense reimbursement plans, cafeteria plans, flexible spending accounts, health savings accounts, health reimbursement accounts, and Archer medical savings accounts. However, if the plan participant gets a prescription for the over-the-counter medication, then it can be reimbursed because it is treated as a prescription drug.

Under IRC Section 106(f), expenses incurred for medicines or drugs may be paid or reimbursed by an employer-provided plan, including a health FSA or HRA, only if the medicine or drug:

(1)     requires a prescription;

(2)     is available without a prescription, that is, is an over-the-counter medicine or drug, (before 2020, the individual was required to obtain a prescription); or

(3)     is insulin.

These rules generally apply to expenses incurred for taxable years beginning on or after January 1, 2011. Congress removed the prescription requirement for over-the-counter drugs in 2020.

Additionally, for plan years beginning in 2013 and thereafter, contributions to flexible savings accounts are limited to $3,200 per year (in 2024, $3,050 in 2023, $2,850 in 2022, $2,750 for 2020-2021 and $2,700 for 2019), as indexed for inflation in subsequent years.¹ Flexible spending accounts are those accounts, typically in cafeteria plans, that may be used to reimburse medical or dependent care expenses.

Further, the IRS has modified the cafeteria plan use it or lose it rule for health FSAs. Health FSAs may now be amended so that $640 (as indexed in 2024, up from  $610 in 2023, $570 in 2022 and $550 in 2021) of unused amounts remaining at the end of the plan year may be carried forward to the next plan year.² However, plans that incorporate the carry forward provision may not also offer the two-month grace (run-out) period that would otherwise allow FSA participants an additional two-month period after the end of the plan year to exhaust account funds.

1.    Rev. Proc. 2019-44 Rev. Proc. 2020-45, Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34.

2.    Notice 2013-71.

GCM 201413005 states that carrying over FSA funds from year one to year two will prevent an individual from participating in a health savings account (HSA) in year two. HSA-eligible individuals must have qualifying high-deductible health plan (HDHP) coverage and no non-HDHP coverage other than permitted insurance, coverage providing only certain types of preventive care, or coverage with a deductible that equals or exceeds the statutory minimum annual HDHP deductible (collectively, HSA-compatible coverage). Unused amounts from a general-purpose health FSA that could be carried over to an HSA-compatible health FSA may be used during the general-purpose health FSA’s run-out period to reimburse expenses covered by the general-purpose health FSA that were incurred during the previous plan year.

A health FSA that reimburses all qualified Section 213(d) medical expenses without other restrictions is a health plan. Consequently, an individual who is covered by a general purpose health FSA that pays or reimburses qualified medical expenses is not an eligible individual for purposes of contributing to an HSA. This disqualification includes the entire plan year, even if the health FSA has paid or reimbursed all amounts prior to the end of the plan year. To prevent this, an individual may decline or waive a health FSA carryover in order to become eligible for the HSA, at least if the FSA plan permits.

A cafeteria plan may provide that if an individual participates in a general purpose health FSA that provides for a carryover of unused amounts, the individual may elect prior to the beginning of the following year to decline or waive the carryover for the following year. In that case, the individual who declines under the terms of the cafeteria plan may contribute to an HSA during the following year if the individual is otherwise eligible for the HSA.

However, if a cafeteria plan offers an HSA-compatible (limited purpose) health FSA, (i.e., one that covers, dental, vision, preventive care, and/or pharmaceutical expenses not covered under a health insurance plan) this does not prohibit funding an HSA. Thus, individuals wishing to participate in an HSA should either not carryover any FSA funds into the next plan year or make sure carryover funds are deposited in an HSA-compatible FSA (i.e., one that provides solely incidental benefits or reimburses other medical expenses after the deductible is met). There is no requirement that the unused amounts in the general purpose health FSA only be carried over to a general purpose health FSA. However, the carryover amounts may not be carried over to a non-health FSA or another type of cafeteria plan benefit.

Thus, if a carryover feature is included in the general-purpose health FSA plan, an employer has three options available to preserve employees’ HSA eligibility for the following plan year:

• Option 1: Allow participants with a general-purpose health FSA to elect and enroll in a limited-purpose FSA — an FSA plan that is compatible with an HSA — for the following plan year. Those participants can carry over unused funds (up to the maximum limit) to a limited-purpose FSA; however, the carryover cannot be applied to another non-health FSA or another cafeteria plan benefit.
• Option 2: Automatically enroll participants in a limited-purpose FSA if those participants enroll in a qualifying high deductible health plan (HDHP) and have a carryover balance in a general-purpose health FSA.
• Option 3: Allow individuals to waive or decline a health FSA carryover prior to the beginning of the next plan year to become eligible.

Planning Point: An employer may have both a general purpose health FSA and an HSA-compatible FSA. Where an employee participates in both and does not utilize all elected benefits in a year, GCM 201413005 provides an example for maximizing the benefits for the succeeding year while maintaining eligibility to participate in an HSA, as follows:

Example: Employer offers a calendar year general purpose health FSA and a calendar year HSA-compatible health FSA. Both FSAs provide for a carryover of up to $500 of unused amounts and do not have a grace period. Employee has an unused amount of $600 in the general purpose health FSA on December 31 of Year 1. Prior to December 31 of Year 1, Employee elects $2,500 in the HSA-compatible health FSA for Year 2 and elects to have any carryover go to the HSA-compatible health FSA. Employee also elects coverage by an HDHP for Year 2. In January of Year 2, Employee incurs and submits a claim for $2,700 in dental care covered by the HSA-compatible health FSA. The plan timely reimburses $2,500, the amount elected. In February of Year 2, Employee submits and is reimbursed from the general purpose health FSA for $300 in medical expenses incurred prior to December 31 of Year 1. At the end of the run-out period, $300 in the general purpose health FSA is unused and carried over to the HSA-compatible health FSA. Employee is then reimbursed $200 for the excess of the January claim over the amount elected for the HSA-compatible health FSA. Employee has $100 remaining in the HSA-compatible health FSA to be used for expenses incurred in the year or carried over to the next year. Employee is allowed to contribute to an HSA as of January 1 of Year 2.

No. An employer cannot sponsor a stand-alone health FSA. An employer may only offer a health FSA if it also offers a major medical plan to the health FSA participants, who are not required to accept the offer of coverage in the employer’s major medical plan.

Editor’s Note: Final rules expanding the availability of HRAs to allow employees to purchase individual health insurance with HRA funds were released in 2019. See Q 448 for details.

Prior to release of the new rules expanding the availability of HRAs in 2019, the IRS had issued guidance providing that a health reimbursement arrangement (HRA) could not be integrated with individual coverage (whether purchased in the individual insurance markets or an exchange) in order to comply with the ACA prohibition against annual dollar limits on benefits available under a plan, eliminating the possibility that employers could use HRAs to subsidize employees’ purchase of health insurance.¹ This was the case unless certain specific criteria were met (see below).

Pre-2020, IRS guidance provided the circumstances under which an HRA could be integrated with a health plan so that it did not violate the annual dollar limit prohibition. An HRA could be integrated with another health plan (and, thus, not violate the prohibition against annual dollar limits) if it met one of two tests.

First, an HRA could be integrated if (1) the employer offered a second group health plan that did not consist solely of certain excepted benefits, (2) the employee receiving the HRA was actually enrolled in that group health plan or a spouse’s plan, (3) the HRA was only available to employees enrolled in the non-HRA group coverage, (4) the HRA was only permitted to reimburse one or more of: co-payments, co-insurance, deductibles, and premiums under the non-HRA coverage, or medical expenses for non-essential benefits and (5) the employee was permitted to opt-out of the HRA.

Under the second method, if the HRA did not limit reimbursements as required under the first method, (1) the employer was required to offer a group health plan in addition to the HRA that provided certain minimum value under IRC Section 36B, (2) the employee must actually have enrolled in that plan or a spouse’s plan, (3) the HRA must only have been available to employees enrolled in the non-HRA plan and (4) the employee must have been permitted to opt-out.

An exception to these rules applied for employer sponsored HRAs offered to one participant or solely to retirees. These HRAs may be offered on a stand-alone basis without its participant(s) being covered by the employer’s major medical health plan.

1.    Notice 2013-54, 2013-40 IRB 287.

The DOL, Department of Health and Human Services (HHS) and Treasury released new regulations, finalized in 2019, that expand the potential value of HRAs. Under the new rules, individual coverage HRAs (ICHRAs) can be used to reimburse employees for the cost of individually purchased health insurance plans. The expanded HRA rules were effective January 1, 2020.

Planning Point: While QSEHRAs expanded the availability of HRAs that can be used to reimburse employees for the cost of individual health insurance premiums, QSEHRAs can only be used by employers that are not subject to the employer mandate, limiting their usefulness to owners of fairly small businesses.

The new rules would allow all sizes of employers to reimburse premiums for individual health insurance coverage through HRAs if the following conditions are satisfied:

(1)     All individuals enrolled in the HRA are also enrolled in individual coverage or Medicare. If an individual ceases to be enrolled in individual coverage, the HRA must stop reimbursing their medical expenses (applied prospectively only). Individuals who are still within the grace period with respect to paying their premiums for individual coverage are considered enrolled in individual coverage.

(2)     The employer does not offer integrated HRA-individual coverage to one class of employees if it offers group health coverage to others in the same class of employees, and

(3)     The HRA must be offered on the same terms to members of employees within a given class of employees. Consistent definitions must be used to determine employee classifications. Exceptions to this rule include classes based on age and for family size (see below).¹

As was the case under earlier guidance, the HRA program must include an opt-out provision that will allow the employee to claim the premium tax credit. The employee must be able to opt out at least annually and, for most employees, at the start of the plan year. If the employee becomes eligible to participate at a date other than the first day of the plan year, or a dependent becomes newly eligible to participate during the plan year, the opt-out opportunity must be provided during the enrollment period established by the HRA for those individuals. Upon termination, the amounts must be forfeited or the participant must be able to permanently opt out and waive any future reimbursements.² If the employee opts out, and the HRA is unaffordable or the HRA does not provide minimum value, the employee would be eligible for the premium tax credit.

While the HRA must be offered on the same terms to members within a given class, variations in dollar amounts are permitted when based on the number of dependents covered under the plan (so long as the same maximum dollar amount attributable to increases in family size is available to all participants in the same class of employees with the same number of dependents) or due to age under certain circumstances (see Q 449 for more information on the class limitations).³

Reasonable substantiation procedures must be established to ensure that employees actually are enrolled in individual health insurance plans. Generally, substantiation must be provided no later than the start of the plan year, unless the employee is not eligible to participate on that date, in which case substantiation should be required no later than the date when HRA coverage begins.⁴

Employers are permitted to ensure that employees actually use the HRA funds to purchase individual health insurance satisfying ACA minimum coverage requirements—rather than limited or short duration plans—by relying upon employee attestations. The rules are clear that employers are not required to look beyond employee attestations to confirm that the employee used the funds permissibly (unless the employer has actual knowledge that the attestation may be false).⁵ However, the employer must obtain an attestation for each reimbursement from the HRA.⁶ The rules provide model attestation language, and also suggest verification by requiring the employee to provide an insurance card or similar document.⁷

The HRA is also required to provide detailed written notice to participants at least 90 days prior to each plan year (the rules provide model notices, see Q 454).

See Q 453 for a discussion of the new excepted benefit HRAs that are also available beginning in 2020.

1.    Treas. Reg. § 54.9802-4(c).

2.    Treas. Reg. § 54.9802-4(c)(4).

3.    Treas. Reg. § 54.9802-4(c)(3)(iii).

4.    Treas. Reg. § 54.9802-4(c)(5)(i).

5.    Treas. Reg. § 54.9802-4(c)(5)(iii).

6.    Treas. Reg. § 54.9802-4(c)(5)(ii).

7.    Treas. Reg. § 54.9802-4(c)(5)(i)(B).

Individual coverage HRAs (ICHRAs) may be offered on different terms to employees included in different “classes”. The employer is required to determine the classes of employees that it intends to treat separately and the definition of the relevant classes that will apply when choice is permitted. Changes are not permitted other than before the start of a new plan year.¹

Permissible classes of employees include part-time employees, full-time employees, seasonal workers, hourly workers, salaried workers, new hires, workers employed or not employed through a temporary staffing agency, employees in the same rating area, employees covered by a collective bargaining agreement in which the plan sponsor participates, employees who have satisfied a waiting period for coverage, and non-resident aliens.² The class of employees who have yet to reach age 25 was not included in the final rule.

Under the final rule, ICHRA coverage offered to a class of employees grouped together based upon full-time status, part-time status, geography or status of the worker as salary versus hourly are only permitted when the group is of a sufficient size. Generally, the size requirement only applies if the employer also offers a traditional group health plan to certain employees in addition to the ICHRA. If the group is only offered traditional group health coverage or no coverage at all, the size requirement does not apply.³ The size requirement does apply if the employer combines one or more permissible classes of employees, except the size requirement does not apply if the employer combines one permissible class of employees with a class of employees that have not yet satisfied a waiting period for coverage.⁴

Under the rule, for employers with between 100 and 200 employees, the class size must be the smaller of 20 employees or 10 percent of the workforce. For employers with fewer than 100 employees, the class size must be at least 10 employees, and for employers with more than 200 employees, the class size must be at least 20 employees.⁵ The minimum size requirement does not apply when the class is based on a geographic grouping that encompasses one or more entire states.⁶ The employer determines whether a class of employees satisfies the size requirements based on the number of employees in the class offered the ICHRA as of the first day of the plan year (i.e., it is not based on the number of employees who actually enroll and not impacted by changes in the number of employees throughout the plan year).⁷

The minimum size requirement does generally not apply to the “new hire” class of employees, unless the employer later subdivides the “new hire subclass” into additional subclasses where the size requirement would apply.⁸ An employer may generally prospectively offer new hires within a class of employees who are hired on or after a certain date an ICHRA while continuing to offer existing employees within that same class traditional group health coverage. This means that a “new hire subclass” is permissible within a class of employees. The ICHRA must be offered on the same terms to all participants within the new hire subclass. Under these circumstances, the employer cannot offer a choice between group health coverage and an ICHRA to any employee in the new hire subclass, or to any employee in the class who is not a member of the new hire subclass.⁹ The relevant date can be established as any date on or after January 1, 2020.¹⁰ The plan sponsor is also permitted to discontinue the special rule for new hires, and later reapply the new hire rule, but only on a prospective basis.¹¹

An employer need not offer an ICHRA to all former employees, or to all former employees within the same class. However, if the employer chooses to do so, the ICHRA must be offered on the same terms as for other employees in the class (former employees are included in the class they would have fallen into immediately before separating from service).¹²

Under the final rule, ICHRA contributions cannot vary by more than 3:1 for older employees versus younger employees. Further, the same maximum dollar amount attributable to increases in age must be available to all participants who are the same age. The employer can use any reasonable method to determine the age of participants, so long as the same method is used for all participants in the same class of employees.¹³ A consistency requirement applies in determining the definition of “full-time”, “part-time” and seasonal employee for the plan year.¹⁴

Planning Point: In response to age discrimination concerns, the EEOC released a letter clarifying employers’ contribution options. Employers are entitled to use a defined contribution method—meaning that every employee receives the same employer contribution. Under this scenario, older employees could bear a larger burden in terms of their own financial contribution to the insurance premium because of age. Employers can also provide a specified percentage of premium costs to employees (which would mean that older employers could receive a larger contribution). It’s important to note that the Age Discrimination in Employment Act (ADEA) applies only to employer plans. In the ICHRA context, the employer has no control over the plan—because the employee chooses their own coverage option.

1.    Treas. Reg. § 54.9802-4(d)(2).

2.    Treas. Reg. § 54.9802-4(d)(2).

3.    Treas. Reg. § 54.9802-4(d)(3)(ii)(B).

4.    Treas. Reg. § 54.9802-4(d)(3)(ii)(D).

5.    Treas. Reg. § 54.9802-4(d)(3)(iii).

6.    Treas. Reg. § 54.9802-4(d)(3)(ii)(C)(1).

7.    Treas. Reg. § 54.9802-4(d)(3)(iv).

8.    Treas. Reg. §§ 54.9802-4(d)(3), 54.9802-4(d)(5)(iv).

9.    Treas. Reg. § 54.9802-4(d)(5).

10.      Treas. Reg. § 54.9802-4(d)(5)(ii).

11.      Treas. Reg. § 54.9802-4(d)(5)(iii).

12.      Treas. Reg. § 54.9802-4(d)(2).

13.      Treas. Reg. § 54.9802-4(c)(3)(iii)(B).

14.      Treas. Reg. § 54.9802-4(d)(4).

Employees who receive integrated individual coverage via an HRA are generally not eligible for the premium tax credit, but they are eligible for a special enrollment period in the individual market to purchase health insurance. While the general enrollment period in the marketplace occurs in November and December, the regulations provide that a special enrollment event will be deemed to occur when an individual is given the option of participating in an individual coverage HRA.

Despite this, individual coverage HRAs are treated as group health insurance plans under the ACA. This means that if the employee chooses to opt out because the coverage provided is not affordable and then enrolls in individual coverage via the health insurance marketplace, the individual may remain eligible to claim the premium tax credit. An individual coverage HRA is affordable for purposes of claiming the premium tax credit if the employee’s required HRA contribution does not exceed 1/12 of (1) the employee’s household income for the year multiplied by (2) the required contribution percentage.¹ The employee’s “required contribution” is determined by subtracting (1) the monthly premium for the lowest cost silver plan for self-only coverage of the employee offered on the health insurance exchange for the rating area in which the employee lives from (2) the monthly self-only HRA contribution. For 2023, the required contribution percentage is 9.12% (9.61 percent in 2022, 9.83 percent in 2021 and 9.78 percent in 2020).

If the individual coverage is deemed to be unaffordable at the time the employee enrolls in individual coverage through the marketplace after opting out, the individual coverage HRA will be deemed unaffordable for the entire year.²

1.    Treas. Reg. § 1.36B-2(c)(5)(i).

2.    Treas. Reg. § 1.36B-2(c)(5)(iv).

Individual coverage HRAs are group health insurance plans, so can be used to satisfy the employer mandate, as they are deemed to provide minimum essential coverage so long as all participants are actually enrolled in individual coverage or Medicare as required under the new regulations.¹ This means that employers who are required to provide coverage under the ACA can satisfy the employer mandate requirements through offering an individual coverage HRA, assuming the HRA is affordable and meets applicable minimum value standards, and assuming the HRA is offered to at least 95 percent of full-time employees and dependents (i.e., it satisfies all of the rules that otherwise apply with respect to the employer mandate, see Q 469).

The IRS has released two safe harbor rules in a new set of proposed regulations designed to facilitate the use of individual coverage health reimbursement arrangements (HRAs) in order to provide employees with a tax-preferred method to pay for health insurance premiums in the individual marketplace. If an employer qualifies under one of the safe harbors, that employer can avoid becoming subject to the shared responsibility provisions of the ACA based upon its use of individual coverage HRAs. Under the first safe harbor, the employer can calculate whether a health plan is affordable based upon the minimum cost of a silver plan offered through the health insurance marketplace in the employee’s location. Under the second safe harbor, the employer can use the prior year’s cost of a silver plan in the month of January.

Planning Point: It’s notable that the IRS has not provided a similar safe harbor for the IRC Section 105(h) nondiscrimination rules. Under Section 105(h), employers are prohibited from discriminating in favor of highly compensated employees by providing increased benefits to these employees. However, the final rules governing ICHRAs allow employers to provide increased amounts based on an employee’s age provided the reimbursements otherwise satisfy the rule’s criteria. Although these increased reimbursements will generally not violate the Section 105(h) rule, there is no safe harbor for employers to rely upon. Therefore, when choosing to reimburse older employees (who may face increased premium costs) at a higher rate, employers should remain vigilant about not favoring highly compensated older employees over non-highly compensated older employees to avoid penalties.

Affordability must be determined on an employee-by-employee basis, considering each employee’s income, any required HRA contribution and the lowest cost silver marketplace plan that is available to that employee.

1.    Notice 2018-88.

Yes. There is no requirement that a participant and his or her dependents be covered under the same type of plan, so that an individual coverage HRA may be provided to an employee-participant who is covered under Medicare and to his or her dependents, who are covered under individual health insurance coverage obtained in the marketplace.¹

1.    Treas. Reg. § 54.9802-4(e).

Beginning in 2020, employers are permitted to offer excepted benefit HRAs under the 2019 HRA regulations. Employees can use the funds in an excepted benefit HRA to purchase certain “excepted” benefits and short-term health insurance coverage. Unlike with individual coverage HRAs, employers can offer both the excepted benefit HRA and group health insurance coverage to the same employee without any requirement that the employee actually enroll in the group health coverage.

Excepted benefit HRAs can be used to pay co-pays, dental or vision coverage, short-term health insurance premiums and other medical expenses not covered under the group health plan. The funds cannot be used to pay individual health insurance premiums or Medicare premiums.

The excepted benefit HRA is funded solely by the employer. The annual contribution limit is currently $2,100 per year (up from $1,950 for 2023).¹

1.    Treas. Reg. § 54.9831-1(c)(3)(viii), Rev. Proc. 2022-24, Rev. Proc. 2023-23.

An employer who offers individual coverage HRAs (ICHRAs) must comply with certain notice requirements, which mandate that the employer offering the ICHRA provide written notice to each participant at least 90 days before the beginning of the plan year.¹ If the participant is not eligible as of the first day of the plan year, the notice must be provided no later than the date the ICHRA may take effect for the participant.² The notice must contain a description of the basic ICHRA terms, including:

1. the maximum dollar amount available to each participant for the plan year;
2. any rules regarding pro-ration if the participant is not eligible for the entire plan year;
3. whether dependents are eligible;
4. a statement disclosing that there are different types of HRAs (including QSEHRAs) and that the particular HRA being offered is an individual coverage HRA;
5. a statement that the participant and any dependents must be enrolled in qualifying individual health insurance coverage or Medicare;
6. a statement that the coverage cannot be short-term, limited-duration or excepted benefit only coverage;
7. a statement as to ERISA coverage;
8. the date ICHRA coverage will first become effective (with respect to all participants and dependents covered);
9. the date the ICHRA plan year begins and ends; and
10. the dates the amounts under the ICHRA will become available.³

The notice must contain information about the availability of the premium tax credit and the employee’s right to opt out of the ICHRA. The notice must also clearly state that the employee will be ineligible for the premium tax credit if he or she participates in the individual coverage HRA.⁴ The notice must inform the participant that he or she must provide a statement to the exchange if the participant opts out and applies for the premium tax credit, and that statement must disclose availability of the individual coverage HRA, as well as information about available amounts and who the ICHRA would cover.⁵

The notice must inform the participant that he or she will be required to provide substantiation in order to obtain reimbursements from the ICHRA and that if individual coverage or Medicare coverage ceases, the participant will no longer be eligible for reimbursement.⁶ The notice should also contain contact information where the participant can obtain additional information, as well as a statement as to the availability of a special enrollment period in the health insurance marketplace.⁷

The DOL has provided a model notice that can be used in order to demonstrate good faith compliance with the notice requirements.

Planning Point: The IRS released instructions for Forms 1094 and 1095 that contain reporting information for clients who have decided to offer ICHRAs beginning in 2020. Forms 1095-B and 1095-C are provided to both the IRS and the employee who receives coverage. For Form 1095-B, a new “Code G” will be entered to identify the ICHRA as the source of employer-provided coverage (ICHRA coverage counts as a form of minimum essential coverage). Form 1095-C, Line 14, asks for information about the coverage and the employee, including (1) whether the employee is full-time or part-time, (2) whether the spouse or dependents were offered coverage, (3) whether the ICHRA is affordable by ACA standards for full-time employees and (4) the location used to determine affordability. The forms will also ask for the employee’s age and zip code (whether for primary residence or the employment location). The employee’s ICHRA contributions now count for purposes of determining whether the employee’s contribution is affordable. The forms confirm that the employer has the choice of basing affordability on either the location of the employee’s primary residence or primary work site.

1.    Treas. Reg. § 54.9802-4(c)(6)(i)(A).

2.    Treas. Reg. § 54.9802-4(c)(6)(i)(B).

3.    Treas. Reg. § 54.9802-4(c)(6)(ii)(A).

4.    Treas. Reg. § 54.9802-4(c)(6)(ii)(B), (C), (D).

5.    Treas. Reg. § 54.9802-4(c)(6)(ii)(E).

6.    Treas. Reg. § 54.9802-4(c)(6)(ii)(G), (H).

7.    Treas. Reg. § 54.9802-4(c)(6)(ii)(I), (J).

Generally, no. However, see Q 448 to Q 454 for more information on the new rules that allow reimbursement through individual coverage HRAs.

The ACA market reform provisions generally prohibit employers from reimbursing employees for individual health insurance premiums.¹ This is because these types of employer-sponsored reimbursement arrangements typically place a cap on the amount that the employer will reimburse for these expenses, in violation of the ACA prohibition on annual benefit limits. This is the case whether or not the payments are treated as pre-tax or after-tax to the employee. However, IRS Notice 2015-17 provides an exception for employers not subject to the employer mandate (they are not applicable large employers) and the shareholders of S corporations. These two types of employers were permitted to continue to reimburse individual health insurance premiums through June 30, 2015 without penalty.

This relief was extended by the introduction of QSEHRAs (see Q 350), which allow certain small employers to reimburse employees for the cost of health insurance premiums through HRAs, and further through the introduction of ICHRAs, available to employers of all sizes.

See Q 447 for a discussion of situations where an employer-sponsored reimbursement arrangement may be treated as integrated with another type of policy so as to avoid violating the prohibition on annual benefit limits.

1.    See Department of Labor FAQ about Affordable Care Act Implementation (Part XXII), updated November 6, 2014, available at: www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/aca-part-xxii.pdf.

Reimbursement arrangements whereby an employer reimburses its employees for the cost of individual health insurance premiums generally are themselves considered group health plans and cannot be integrated with individual policies in order to satisfy the market reform provisions of the Affordable Care Act (ACA). (However, see Q 448 to Q 454 for information on the newly available individual coverage HRAs.).

As a result, these arrangements will typically violate the ACA prohibition on annual benefit limits and provision of preventive care without employee costs, and will cause the employer to be subject to a $100 per day penalty per employee.¹ This penalty is subject to the guidance provided in IRS Notice 2015-17 and the 21st Century Cures Act, which provide relief to small employers who are not applicable large employers subject to the employer mandate and to S corporations in regard to their shareholders.

1.    See IRS FAQ, Employer Health Care Arrangements, updated September 29, 2022, available at http://www.irs.gov/Affordable-Care-Act/Employer-Health-Care-Arrangements. See also IRC § 4980D.

For amounts paid after December 31, 2010 and before 2020, a distribution from an HSA or Archer MSA¹ for a medicine or drug was a tax-free qualified medical expense only if the medicine or drug (1) required a prescription, (2) was an over-the-counter medicine or drug and the individual obtained a prescription, or (3) was insulin. The prescription requirement for over-the-counter drugs was eliminated beginning in 2020.

If amounts are distributed from an HSA or Archer MSA for any medicine or drug that does not satisfy these requirements, the amounts are distributions for nonqualified medical expenses, which are includable in gross income and generally are subject to a 20 percent additional tax. This change does not affect HSA or Archer MSA distributions for medicines or drugs made before January 1, 2011, nor does it affect distributions made after December 31, 2010, for medicines or drugs purchased on or before that date.

IRS guidance reflecting these statutory changes makes it clear that the rules in IRC Sections 106(f), 223(d)(2)(A), and 220(d)(2)(A) do not apply to items that are not medicines or drugs, including equipment such as crutches, supplies such as bandages, and diagnostic devices such as blood sugar test kits. These items may qualify as medical care if they otherwise meet the definition of medical care in IRC Section 213(d)(1), which includes expenses for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.

Expenses for items that are merely beneficial to the general health of an individual, such as expenditures for a vacation, are not expenses for medical care.

1.    IRC § 223(d)(2)(A), IRC § 220(d)(2)(A).

Another issue to consider is the use of health flexible spending account (“FSA”) or health reimbursement account (“HRA”) debit cards. The current rules are set forth in Proposed Treasury Regulation Section 1.125-6 and in Revenue Ruling 2003-43, 2003-1 C.B. 935; Notice 2006-69, 2006-2 C.B. 107; Notice 2007-2, 2007-1 C.B. 254; and Notice 2008-104, 2008-2 C.B. 1298.

Debit card systems have not been capable of substantiating compliance with new IRC Section 106(f) with respect to over-the-counter medicines or drugs because the systems were incapable of recognizing and substantiating that the medicines or drugs were prescribed. Therefore, except as noted below, for expenses incurred on and after January 1, 2011, these health FSA and HRA debit cards could not be used to purchase over-the-counter medicines or drugs. The IRS indicated, however, that to facilitate the significant changes to existing systems necessary to reflect the statutory change, it would not challenge the use of health FSA and HRA debit cards for expenses incurred through January 15, 2011, if the use of the debit cards complied with then current rules.

The IRS made it clear, however, that on and after January 16, 2011, over-the-counter medicine or drug purchases at all providers and merchants, whether or not they have an inventory information approval system (“IIAS”), must be substantiated before reimbursement may be made. Substantiation is accomplished by submitting the prescription, a copy of the prescription, or, prior to 2020, other documentation that a prescription has been issued for an over-the-counter medicine or drug and other information from an independent third party that satisfies the requirements under Proposed Treasury Regulation Section 1.125-6(b)(3)(i). The prescription requirement for over-the-counter drugs was eliminated in 2020.

Thus, for example, the substantiation requirements for over-the-counter medicines or drugs are satisfied by (1) a receipt without a prescription number accompanied by a copy of the prescription or (2) a customer receipt issued by a pharmacy that identifies the name of the purchaser or the name of the person for whom the prescription applies, the date and amount of the purchase, and a prescription number. Debit cards may continue to be used for medical expenses other than over-the-counter medicines or drugs.

Health FSA and HRA debit cards may be used at a pharmacy that does not have an IIAS if 90 percent of the store’s gross receipts during the prior taxable year consisted of items that qualified as expenses for medical care under IRC Section 213(d).

Prior to 2020, IRS guidance provided that debit cards could be used at a pharmacy that satisfied the 90 percent test to purchase over-the-counter medicines or drugs that had been prescribed provided that substantiation was properly submitted in accordance with the terms of the plan, including the prescription or a copy of the prescription or other documentation that a prescription had been issued, and other information from an independent third party that satisfied the requirements under Proposed Treasury Regulation Section 1.125-6(b)(3)(i). Solely for the purpose of determining whether a pharmacy meets this 90 percent test, sales of over-the-counter medicines and drugs at the pharmacy may continue to be taken into account after December 31, 2010.

For tax years beginning after December 31, 2010, health care reform originally required that employers disclose the value of benefits provided for each employee’s health insurance coverage on employee W-2 forms. This reporting was to give the federal government statistical information and did not change the income tax treatment for employers or employees.

The required reporting rules were delayed twice. Health care reform required W-2s for the 2011 year to provide the cost of health coverage. That requirement was delayed and made applicable for W-2s issued for the 2012 year. Additionally, IRS Notice 2011-28 (as modified by Notice 2012-9) provides an exemption for this delayed reporting requirement. Until further notice from the IRS, an employer is not subject to the reporting requirement for any calendar year if the employer was required to file fewer than 250 Forms W-2 for the preceding calendar year. The IRS has advised that any guidance expanding the reporting requirements will apply to calendar years that begin at least six months after the date that such guidance is issued.

Planning Point: If employees talk to one another, the new W-2 reporting may mean that employees can discover that their employer pays nothing for some employees and thousands for others, especially in grandfathered plans that are not subject to nondiscrimination rules so long as they retain their grandfathered status. It has been quite common for small employers to provide family coverage for owners and key employees, to provide single employee coverage often with less than 100 percent of cost for other employees, and to exclude employees who have health insurance through another source, such as a spouse’s employment.

The ACA created simple cafeteria plans for small businesses, meaning those with average employment of 100 or fewer employees, effective for years beginning in 2011 and thereafter. The concept is similar to 401(k) retirement plan safe harbors, SIMPLE 401(k)s, and SIMPLE-IRAs.

Employer and employee contributions are deductible, not subject to Social Security tax, and not taxable income to participants. Thus, available benefits can be purchased with pre-tax dollars. Available benefits include health and dental insurance, reimbursement for health and dental expenses not covered by insurance, dependent care, group term life insurance, health savings accounts, and disability insurance.

Simple cafeteria plans automatically satisfy the nondiscrimination requirements of IRC Section 125(b), the 25 percent concentration test, and nondiscrimination requirements of IRC Sections 79(d), 105(h), and 129(d) applicable to group term life insurance, self-insured health benefits (medical reimbursement), and dependent care assistance benefits (child care), respectively.

Through an apparent oversight, IRC Section 125(j) does not provide an express exception for the health insurance nondiscrimination rules of IRC Section 9815. It is likely that if the same insurance options are available to all participants, regardless of their use, the health insurance nondiscrimination rules will be met.

Where a business wants to avoid the 25 percent concentration test and contribute for owner-employees, only a regular C corporation can do so because owner-employees are only employees for income tax purposes in this context. Sole proprietors, 2 percent or more S corporation shareholders, and partners, including members of LLCs taxed as partnerships, are not employees for income tax purposes. Instead, they are treated as self-employed individuals.

100 or Fewer Employees

An employer is eligible to implement a simple cafeteria plan if, during either of the preceding two years, it employed 100 or fewer employees on average, based on business days.

For a new business, eligibility is based on the number of employees the business reasonably is expected to employ.

Businesses maintaining a simple cafeteria plan that grow beyond 100 employees can continue to maintain the simple arrangement until they have exceeded an average of 200 or more employees during a preceding year.

Employees include leased employees.

Controlled and Affiliated Service Groups

For purposes of determining an eligible employer, employer aggregation rules govern under (1) IRC Section 52, which applies the rules of IRC Section 1563, except “more than 50 percent” is substituted for “at least 80 percent” in IRC Section 1563(a)(1), and subsections 1563(a)(4) and 1563(e)(3)(C) are disregarded, and (2) IRC Section 414, relating to controlled and affiliated service groups. Additionally, an employer includes a predecessor employer, which is undefined for these purposes.

Qualified Employees

All non-excludable employees who had at least 1,000 hours of service during a preceding plan year must be eligible to participate in a simple cafeteria plan. The term qualified employee means any employee who is not a highly compensated employee under IRC Section 414(q) or a key employee under IRC Section 416(i) and who is eligible to participate in a plan.

This definition of qualified employee is relevant only to the two alternative minimum contribution requirements, discussed below, and to highly compensated employees (“HCEs”) and key employees. HCEs and key employees may participate in the same manner as everyone else so long as they are employees and do not receive disproportionate employer nonelective or matching contributions. Comparable contributions must be made for all eligible employees.

Excludable Employees

Excludable employees are those who:

(1)     have not attained age 21 (or a younger age if provided in the plan) before the end of the plan year;

(2)     have less than one year of service as of any day during a plan year;

(3)     are covered under a collective bargaining agreement; or

(4)     are nonresident aliens.

An employer may have a shorter age and service requirement, but only if such shorter service or younger age applies to all employees.

Employees who previously worked 1,000 hours in a plan year, but do not currently, can be excluded because employees who do not have a year of service in the current plan year can be excluded. Because the rule is that they can be excluded if they do not have a year of service on any day in the year, they will have 1,000 hours if they go from full-time to part-time at the beginning of the current year. This is an important point when an employee’s salary is less than the health benefits. The employee should be entitled to the entire maximum benefit if elected, even if greater than compensation, to safeguard simple status.

Benefit Nondiscrimination

Each eligible employee must be able to elect any benefit under a plan under the same terms and conditions as all other participants.

Minimum Contribution Requirement

The minimum must be available for application toward the cost of any qualified benefit, other than a taxable benefit, offered under a plan.

Employer contributions to a simple cafeteria plan must be sufficient to provide benefits to non-highly compensated employees (“NHCEs”) of at least either:

(1)     A uniform percentage of at least two percent of compensation, as defined under IRC Section 414(s) for retirement plan purposes, whether or not the employee makes salary reduction contributions to a plan; or

(2)     The lesser of a 200 percent matching contribution or six percent of an employee’s compensation. Additional contributions can be made, but the rate of any matching contribution for HCEs or key employees cannot be greater than the rate of match for NHCEs under IRC Section 125(j)(B).

The same method must be used for calculating the minimum contribution for all NHCEs. The rate of contributions for key employees and HCEs cannot exceed that for NHCEs. Compensation for purposes of this minimum contribution requirement is compensation within the meaning of IRC Section 414(s).

Editor’s Note: The prescription requirement for over-the-counter drugs was eliminated beginning in 2020.

Cafeteria plans that allow reimbursement for over-the-counter drugs were required to be amended for the new over-the-counter drug requirements. An amendment to conform a cafeteria plan to the new requirements that was adopted no later than June 30, 2011, could be made effective retroactively for expenses incurred after December 31, 2010, or after January 15, 2011, for health FSA and HRA debit card purchases.

Additionally, fiscal year cafeteria plans could be amended to provide that elections to purchase health insurance can be changed mid-year to allow for the purchase of insurance on an exchange or in plan for the fiscal year cafeteria plan year beginning in 2013.

Such an election to purchase or to cease purchasing health insurance could be made mid-year despite the fact that this is not a change in status, which is a normal prerequisite to change a cafeteria plan election. Employees may have wished to terminate their election to purchase health insurance through the employer’s cafeteria plan and go to the exchange if they were eligible for health insurance exchange tax credits. Other employees may have wanted to elect to purchase health insurance from the employer plan effective January 1, 2014 to avoid the individual mandate penalty (which was repealed for tax years beginning after 2018). If the cafeteria plan year is a fiscal year, employees who wished to purchase insurance on an exchange that was effective on January 1, 2014, would have been required to terminate or change their elections mid-year. However, under current cafeteria plan regulations, these two elections are not a change in status allowing an election change mid-year. The proposed regulations allowed an applicable large employer with a fiscal year cafeteria plan, at its election, to amend the plan any time during the year on a retroactive basis (by December 31, 2014, retroactive to the beginning of the 2013 plan year) to permit either or both of the following changes in salary reduction elections:^[1]

(1)     An employee who elected to reduce salary through the fiscal year cafeteria plan for accident and health plan coverage beginning in 2013 was allowed to prospectively revoke or change the election with respect to the accident and health plan once, during that plan year, without regard to whether the employee experienced a change in status event described in Treasury Regulation Section 1.125-4; and

(2)     An employee who failed to make a salary reduction election through the employer’s fiscal year cafeteria plan beginning in 2013 for accident and health plan coverage before the deadline in Proposed Treasury Regulation Section 1.125-2 for making elections was allowed to make a prospective salary reduction election for accident and health coverage on or after the first day of the 2013 plan year of the cafeteria plan without regard to whether the employee experienced a change in status event described in Treasury Regulation Section 1.125-4.

Planning Point: Some provisions of the transition relief refer to “applicable large employer members” (i.e., employers that are subject to healthcare reform’s employer mandate), raising questions as to whether the relief is available for all non-calendar-year cafeteria plans or only those that are sponsored by applicable large employer members.

^[1].         Preamble to Proposed Rules on Shared Responsibility for Employers Regarding Health Coverage, 78 Fed. Reg. 217, 237 (Jan. 2, 2013).

Yes.

A business making payments to a service provider other than a corporation aggregating $600 or more for services in the course of a trade or business in a year is required to send an information return (Form 1099) to the IRS (and to the service provider-payee) setting forth the amount, as well as name and address of the recipient of the payment (generally on Form 1099).

The new law changed this requirement so that businesses had to issue 1099 forms to all persons and businesses, including corporations, for which aggregate annual payments are $600 or more, among other things.

Health care reform expanded the 1099 requirements in two ways:

(1)     1099s were required to be issued to corporations, and

(2)     1099s were required to be issued for purchases of goods and products (rather than only services) that exceeded $600 per year.

On April 5, 2011 the Senate approved H.R. 4, the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011, which retroactively repeals expanded Form 1099 information reporting rules. President Obama signed the bill into law on April 14, 2011. Therefore, taxpayers were not required to take any steps in 2012 and thereafter to comply with the new 1099 requirement.

In October of 2011, the Department of Health and Human Services (“HHS”) announced that it had suspended its work on implementing the Community Living Assistance Services and Support (“CLASS”) Act, which was to provide long-term care benefits in voluntary employer sponsored plans. HHS announced that it was unable to find a way to make the program work. The American Taxpayer Relief Act of 2012 formally repealed the CLASS program.

Under the proposed plan, employees of companies that elected to participate would be automatically enrolled, but could elect to opt out. Employees who did not opt out would pay for this coverage through payroll deductions. Other workers and self-employed individuals could have enrolled on their own. Retirees were not eligible.

After an individual paid premiums for five years and had worked for three of those five years, the employee would have been eligible for a cash benefit of about $50 per day if unable to perform two or three activities of daily living, such as walking, bathing, or dressing, or if the individual became cognitively impaired.

HHS had not yet set the premiums, but the American Academy of Actuaries estimated that the premiums could average as much as $125 to $160 per month, or as little as $5 per month for those below the poverty line. The high-end estimate is about the same price that a relatively healthy 50 year old would pay for a private long-term care policy providing about three times that daily benefit for three years. A study by the actuarial consulting firm, Milliman, found that only 8 percent of long-term care claimants who had policies with a three year benefit period exhausted their benefits.

Under the CLASS Act, a person could not be rejected for coverage because of health, so it was meant to help people with medical conditions that do not qualify for private long-term care insurance or are highly rated. Additionally, it would have covered many services that are not eligible for benefits under most long-term care plans, including homemaker services, home modifications, and transportation, that are typically used to help a person stay out of a nursing home.

Editor’s Note: The 2017 tax reform legislation repealed the Affordable Care Act individual mandate that required individuals to purchase health insurance or pay a penalty for tax years beginning after December 31, 2018. The employer mandate and reporting requirements were not repealed.

Health care reform required most Americans to have health insurance beginning in 2014 in order to avoid liability for a monetary penalty referred to as the individual mandate.

Unless exempt, prior to 2019, Americans were required to have major medical health coverage provided by their employer or that they purchase themselves, or they became subject to a fine that was the greater of a flat amount, or a percentage of income (above the tax filing threshold). The amounts were $95 or 1 percent of income in 2014; $325 or 2 percent of income in 2015; and $695 or 2.5 percent of income in 2016. Families paid half the penalty amount for children under 18, up to a cap of $2,085 per family. After 2016, penalties were indexed to the Consumer Price Index. In 2017 and 2018, the inflation-adjusted dollar amount was $695.¹ In no event could the penalty exceed the average national annual cost of a bronze plan purchased on an exchange.² After 2018, the penalty no longer applies.

Exemptions from the individual penalty were granted for financial hardship, religious objections, American Indians, those without coverage for fewer than three months, undocumented immigrants, incarcerated individuals, those for whom the lowest cost plan option exceeds 8 percent of an individual’s income, and those with incomes below the tax filing threshold.³

1.    Rev. Proc. 2016-55.

2.    IRC § 5000A(c).

3.    IRC § 5000A(d).

Editor’s Note: The 2017 tax reform legislation repealed the Affordable Care Act individual mandate that required individuals to purchase health insurance or pay a penalty for tax years beginning after December 31, 2018. The employer mandate and reporting requirements were not repealed. Late in 2019, the 5th Circuit Court of Appeals held that the individual mandate was unconstitutional. The rest of the ACA continues to be effective.

For taxable years ending after December 31, 2013, the ACA required an applicable individual to ensure that the individual, and any dependent of the individual who is an applicable individual, was covered under a health insurance plan that provided minimum essential coverage or else pay a penalty.¹

Applicable individual means, with respect to any month, an individual other than individuals who have religious exemptions, individuals not lawfully present in the United States, and incarcerated individuals.²

No penalty was imposed on an individual who falls under one of the following exemptions:

(1)     an individual whose required contribution for coverage for the month exceeds 8 percent (as indexed after 2014, 8.05 percent in 2015, 8.13 percent in 2016, 8.16 percent in 2017, and 8.05 percent in 2018—the penalty does apply after 2018)³ of the individual’s household income for the most recent taxable year (household income is increased by any exclusion from gross income for any portion of the required contribution made through a salary reduction arrangement);

(2)     taxpayers with income that is less than the amount of the tax exemption on gross income specified in Section 6012(a)(1);

(3)     members of Indian tribes;

(4)     months during short coverage gaps (generally, any month the last day of which occurred during a period in which the applicable individual was not covered by minimum essential coverage for a continuous period of fewer than three months); and

(5)     any applicable individual who for any month is determined by the Secretary of Health and Human Services to have suffered a hardship with respect to the capability to obtain coverage under a qualified health plan.⁴

1.    IRC §§ 5000A(a), 5000A(b)(1), 5000A(d), as added by PPACA 2010.

2.    IRC §§ 5000A(d)(2), 5000A(d)(3), 5000A(d)(4), as added by PPACA 2010.

3.    Rev. Proc. 2014-37, Rev. Proc. 2016-24.

4.    IRC § 5000A(e), as added by PPACA 2010, as amended by HCEARA 2010.

Editor’s Note: The 2017 tax reform legislation repealed the Affordable Care Act individual mandate that required individuals to purchase health insurance or pay a penalty for tax years beginning after December 31, 2018. The employer mandate and reporting requirements were not repealed. The rules discussed below regarding the individual mandate apply for tax years beginning before January 1, 2019.

Minimum essential coverage means coverage under any of the following:

(1)     government sponsored programs (Medicare, Medicaid, the Children’s Health Insurance Program, the TRICARE for Life program, the veterans’ health care program, the health plan for Peace Corps volunteers, and the Nonappropriated Fund Health Benefits Program of the Department of Defense);

(2)     an eligible employer sponsored plan, which means with respect to any employee, a group health plan or group health insurance coverage offered by an employer to the employee that is a governmental plan or any other plan or coverage offered in the small or large group market within a state (including grandfathered health plans);

(3)     plans in the individual market (coverage under a health plan offered in the individual market within a state);

(4)     grandfathered health plans; and

(5)     other health benefits coverage (e.g., a state health benefits risk pool), as the Secretary of Health and Human Services recognizes for this purpose).¹

1.    IRC § 5000A(f), as added by PPACA 2010.

Editor’s Note: The 2017 tax reform legislation repealed the Affordable Care Act individual mandate that required individuals to purchase health insurance or pay a penalty for tax years beginning after December 31, 2018. The employer mandate and reporting requirements were not repealed. Late in 2019, the 5th Circuit Court of Appeals held that the individual mandate was unconstitutional. The rest of the ACA continues to be effective.

If a taxpayer who is an applicable individual, or an applicable individual for whom the taxpayer is liable, fails to meet the requirement of maintaining minimum essential coverage for one or more months, under prior law, a penalty was imposed.¹ If an individual on whom a penalty is imposed files a joint return for the taxable year including that month, the individual and spouse were jointly liable for the penalty.²

The penalty schedule is shown in the Uninsured Penalty Table, below.³

If the penalty applies, a flat penalty applies per each uninsured adult or child under age 18 in a household. The penalty is increased to an amount equal to the income percentage multiplied by the amount of household income in excess of the income tax return filing threshold, if that is greater than the flat penalty. The dollar amount penalty cannot be greater than the household maximum penalty, which is 300 percent of the flat dollar amount;⁵ in the case of the income percentage penalty, it cannot be greater than an amount equal to the national average premium for a bronze plan for the applicable family size involved.⁶

1.    IRC § 5000A(b)(1), as added by PPACA 2010, as amended by PPACA 2010 Section 10106, as further amended by HCEARA 2010.

2.    IRC § 5000A(b),(3)(B), as added by of PPACA 2010 Section 1501(b).

3.    IRC § 5000A(c), as added by of PPACA 2010 Section 1501(b), as amended by PPACA 2010 Section 10106, as further amended by HCEARA 2010.

4.    Rev. Proc. 2016-55, Rev. Proc. 2017-58.

5.    IRC § 5000A(c), as added by of PPACA 2010 Section 1501(b), as amended by PPACA 2010 Section 10106, as further amended by HCEARA 2010 and repealed by the 2017 Tax Act (Pub. Law No. 115-97).

6.    IRC § 5000(A)(c)(1)(B).

Employers with at least 50 full-time equivalent employees (“FTEs”) must offer insurance meeting specified requirements or pay a $2,000 per full-time worker penalty after its first 30 employees if any of its full-time employees receive a federal premium subsidy through a state health insurance exchange (which would occur because the employee was not being offered sufficient coverage through the employer).¹

A different penalty applies for employers of at least 50 full-time equivalent employees that offer some insurance coverage but not enough to meet federal requirements. In this case, the penalty is $3,000 per full-time employee who gets government assistance and buys coverage in an exchange, subject to a maximum penalty of $2,000 times the number of full-time employees in excess of the first 30.²

The amounts are adjusted annually for inflation each year.  The penalties under IRC Section 4980H(a) were decreased to $2,900 in 2025 ($2,970 for 2024).  The penalties under IRC Section 4980H(b) were decreased to $4,350 in 2025 ($4,460 for 2024).

The shared responsibility penalty on employers for failing to provide minimum essential health insurance excludes excepted benefits under Public Health Service Act 2971(c), including long-term care as well as standalone vision and standalone dental plans.

Planning Point: Applicable large employers have received (and will continue to receive) notices regarding liability for the employer shared responsibility penalties via 226J letters. These letters detail the employer’s violation and it is important that any employer who receives a 226J letter responds within the time frame listed in the letter. Letter 226J should contain a deadline for a response, usually 30 days after the letter was issued (employers may request a 30-day extension by calling a 4980H response unit number listed on the letter itself). It is important to get expert advice when drafting the response, but issues to consider include whether the IRS was using the correct data (i.e., was a corrected Form 1094 filed with the IRS in the year to which the letter relates?), whether the plan was a calendar year plan (transition relief may apply) and whether the employer did, in fact, offer minimum coverage during each month.

1.    IRC §§ 4980H(a), 4980H(c)(1).

2.    IRC § 4980H(b).

Previous guidance delayed application of the employer penalty from 2014 to 2015. Final regulations provide new transitional relief for two types of employers. The applicable large employer status (which triggers the potential application of the mandate) for a calendar year is still based on the number of employees in the preceding calendar year.¹ Transition rules, discussed below, included those for non-calendar year health plans, the ability to count employees for less than 12 months in 2014 to determine applicable large employer status, initial offers of health coverage in 2015, dependent coverage, employers with at least 50 but less than 100 full-time and full-time equivalent (FTE) employees, and reduction of the 95 percent offer of health coverage requirement to 70 percent for 2015.

The proposed employer mandate regulations allowed employers with fiscal year cafeteria plans to amend their cafeteria plans to permit employees to elect or revoke health coverage elections mid-year even absent a corresponding change in status or cost of coverage change during a non-calendar plan year that began in 2013.² The final regulations did not extend this relief. The following rules also apply:

If the employer had on average fewer than 50 full-time (and full-time equivalent) employees (FTEs) in 2014:

• No change. The employer is not subject to the mandate. Employers close to the 50-employee threshold may count employees during any consecutive six-month period (as chosen by the employer) during 2014.

If the employer had on average between 50 and 99 FTEs in 2014:

• The employer had a one-year delay in the employer mandate, until January 1, 2016 (and for non-calendar-year plans, any calendar months during the plan year beginning in 2015 that fall in 2016) if:
  • The employer certified it did not lay off employees during the period beginning on February 9, 2014 and ending on December 31, 2014 to fall below the 100 employee threshold and that the employer did not reduce any coverage it was already offering, and
  • During the period beginning on February 9, 2014 and ending on December 31, 2014, the employer did not eliminate or materially reduce the health coverage, if any, offered as of February 9, 2014. An employer was not treated as eliminating or materially reducing health coverage if, for each employee who was eligible for coverage on February 9, 2014:

(a)  The employer offered to make a contribution toward the cost of employee-only coverage that was either (i) at least 95 percent of the dollar amount of the contribution the employer was making toward the coverage in effect as of February 9, 2014, or (ii) at least the same percentage of the cost of coverage that the employer offered to contribute toward coverage in effect as of February 9, 2014;

(b)  Benefits offered as of February 9, 2014 at the employee-only coverage level did not change, or, if it did, the coverage after the change provided minimum value; and

(c)  Eligibility under the employer’s group health plans was not amended to narrow or reduce the class or classes of employees (or the employees’ dependents) to whom coverage under those plans was offered as of February 9, 2014.

• • Such employer must report coverage of employer’s employees for 2015.

If the employer had on average 100 or more FTEs in 2014:

• If an employer failed to offer coverage to a full-time employee for any day of a calendar month, that employee was treated as not having been offered coverage during the entire month. For January 2015, if an employer offered coverage to a full-time employee no later than the first day of the first payroll period that began in January 2015, the employee was treated as having been offered coverage for January 2015.
• Employers with Fiscal Year Health Plans. The employer mandate remained effective on January 1, 2015. However, employers with non-calendar (fiscal) year plans could be subject to the mandate based on the start of their 2015 plan year rather than on January 1, 2015, and other transition relief where certain conditions were met, as follows:

(a)     Pre-2015 Fiscal Year Plan Eligibility Transition Relief. Pre-2015 eligibility transition relief applies to employees, whenever hired, who were:

• • Eligible for coverage on the first day of the 2015 plan year under the eligibility terms of the plan as of February 9, 2014 (whether or not they elected coverage); and
  • Offered affordable coverage that provided minimum value effective no later than the first day of the 2015 plan year.

Where these two conditions were satisfied, the employer was not subject to a potential employer shared responsibility payment until the first day of the 2015 plan year. This relief applied only to employees to whom coverage was previously offered by the employer. Thus, penalties could still be imposed for the months in 2015 that were part of the plan year commencing in 2014 for employees to whom coverage was not previously offered.

(b)     Significant Percentage Fiscal Year Plan Transition Relief (All Employees). No employer mandate penalty applied for any month before the first day of the plan year beginning in 2015 for employees who were offered affordable coverage that provided minimum value by the first day of the 2015 plan year if, as of any date in the 12 months ending on February 9, 2014, an employer:

• • Covered at least one-quarter of its employees (full-time and part-time) under its non-calendar year plan; or
  • Offered coverage under the plan to one-third or more of its employees during the open enrollment period that ended most recently before February 9, 2014.

To qualify for this relief, the employee must not have been eligible for coverage as of February 9, 2014 under any group health plan maintained by his or her employer that has a calendar year plan year.

Planning Point: Unlike the pre-2015 eligibility transition relief discussed above, an employer that qualifies for this relief and who offers affordable, minimum value coverage commencing with the 2015 plan year has no IRC Section 4980H exposure for periods before the 2015 plan year. Relief under this and the next transition rule applies for the period before the first day of the first non-calendar year plan year beginning in 2015 but only for employers that maintained non-calendar year plans as of December 27, 2012, and only if the plan year was not modified after December 27, 2012, to begin at a later calendar date.

• 70 Percent Offer in 2015. For 2015 (and for any calendar months during a non-calendar year plan year beginning in 2015 that fall in 2016), the 95 percent offer of coverage threshold was lowered to 70 percent. Thus, in 2015, an employer would be in compliance if it offered coverage to at least 70 percent of full-time employees and dependents in 2015 unless the employer qualified for the 2015 dependent coverage transition relief, discussed below), although an employer will owe a penalty if at least one of the full-time employees received a premium tax credit for coverage in the public marketplace, which may have occurred because the employer did not offer coverage to that employee or because the coverage the employer offered was either unaffordable or did not provide minimum value.
• Dependent Coverage. In order to avoid exposure for the employer mandate penalty, an employer must offer coverage not only to full-time employees but also to their dependents (but not spouses). The final regulations provided transition relief for plan years that began in 2015 if the employer took steps during the 2015 plan year toward satisfying this requirement in 2016. The transition relief applied to employers for the 2015 plan year for plans under which (i) dependent coverage was not offered, (ii) dependent coverage that does not constitute minimum essential coverage was offered, or (iii) dependent coverage was offered for some, but not all, dependents. This relief was not available, however, if the employer had offered dependent coverage during either the plan year that began in 2013 or the 2014 plan year and subsequently eliminated that offer of coverage.
• In 2016 and after, the employer must offer coverage to at least 95 percent of full-time employees and dependents.
• These applicable large employers must report coverage of employees beginning with 2015.
• An applicable large employer will not be subject to shared responsibility penalties with respect to employees for whom the employer is required (whether by the collective bargaining agreement or appropriate related participation agreement) to make contributions to a multiemployer plan.

1.    Treas. Reg. §54.4980H-2(b).

2.    See Notice 2013-71, which clarified this transition relief.

To calculate the number of FTEs for purposes of determining if an employer is an applicable large employer subject to the employer mandate, full-time is 120 hours per month. If an employer was not in existence during the prior calendar year, an employer is a large employer for the current calendar year if it is reasonably expected to employ at least 50 FTEs. If an employer’s FTEs exceed 50 for 120 days or less and the excess employees are seasonal workers, then the employer is not a large employer.¹

For purposes of the employer mandate penalty assessments (as opposed to determining whether the employer is an applicable large employer), the law defines full-time as 30 hours of service per week, and the regulations provide that 130 (not 120) hours per month is the monthly equivalent, both determined in the current month/year. To address the calculation difficulty concern, the regulations provide alternatives to a month-by-month determination.

For on-going employees, an employer has the option of using a “look-back measurement” method for determining current full-time status. The employer selects a measurement period of three to 12 months and calculates whether the employee on average had 30 hours of service per week (or 130 hours per month) during that period. If so, the employer must treat the employee as full-time during a subsequent “stability period,” which must be at least six months but no shorter than the length of the measurement period. Thus, if the employer used a 12-month look-back measurement period beginning on January 1, 2023, employees who are determined to be full-time must be treated as full-time for all of calendar year 2024.

An employer may also use an optional administrative period of up to 90 days between the measurement period and the stability period in order to determine which on-going employees are eligible for health insurance coverage during the subsequent stability period. However, the administrative period cannot create a gap in coverage. An employee who was enrolled in coverage must remain enrolled during the administrative period.²

1.    IRC § 4980H(c)(2)(B).

2.    Notice 2011-36, 2011-21 IRB 792, Notice 2012-58, 2012-41 IRB 436.

Starting in 2014, the ACA mandated establishment of state-based health insurance exchanges through which individuals and smaller businesses could purchase health insurance coverage, with premium and cost-sharing credits available to individuals and families with incomes between 133-400 percent of the federal poverty level.

For 2023, the federal poverty level is $24,860 for a family of three. The amount increases to $31,070 for Alaska and $28,590 for Hawaii.¹

The 2022 poverty level² (used for the 2023 tax year) for a family of three generally is $23,030, except in Alaska and Hawaii, where it is $28,790 and $26,490, respectively.

The 2021 poverty level³ (used for the 2022 tax year) for a family of three generally is $21,960, except in Alaska and Hawaii, where it is $27,450 and $25,260, respectively.

In addition to meeting the income requirements, a qualifying taxpayer must purchase health insurance on one of the exchanges, must be otherwise unable to obtain affordable coverage through an employer or government program and cannot be eligible to be claimed as a dependent by any other taxpayer. The tax credit can either be paid by the government to the insurance company in advance, or can be refunded to a taxpayer who has already paid for health coverage after the taxpayer files a tax return.

Additionally, beginning in 2014, Medicaid was to be expanded and available to all families with incomes at or below 133 percent of the federal poverty level. However, this Medicaid expansion requires each state to authorize the expansion, and almost half the states have not done so.

On June 28, 2012, the Supreme Court, in National Federation of Independent Business v. Sebelius,⁴ upheld the constitutionality of the Patient Protection and Affordable Care Act, with only minor changes to certain Medicaid provisions.

1. https://www.federalregister.gov/documents/2023/01/19/2023-00885/annual-update-of-the-hhs-poverty-guidelines

2. https://aspe.hhs.gov/topics/poverty-economic-mobility/poverty-guidelines/prior-hhs-poverty-guidelines-federal-register-references/2021-poverty-guidelines.

3. https://www.federalregister.gov/documents/2021/02/01/2021-01969/annual-update-of-the-hhs-poverty-guidelines.

4. 567 U.S. 519 (2012).

Employers with 50 or more full-time equivalent (FTE) employees and more than 30 full-time employees (where full-time employees are those regularly scheduled to work more than 30 hours per week and more than 120 days per year), may be required to pay penalties (in the form of a nondeductible excise tax) for employees who do not receive coverage through the employer and instead purchase health insurance through a state health insurance exchange and receive tax credits (see Q 472). For further description of potential health care coverage penalties, see Q 465.

Employers with fewer than 50 full-time FTE employees are exempt from the penalty. Workers who are independent contractors do not count as employees unless it is found that they actually are employees despite being called independent contractors.

Editor’s Note: Late in 2019, the Cadillac tax was permanently repealed without having gone into effect.

A penalty was set to become effective for employers that offered high cost health coverage options to employees that exceeded the cost of the excess benefit for tax years beginning after December 31, 2021 (the so-called “Cadillac tax”).¹ The applicability date was repeatedly delayed before the repeal. The rules discussed below would have applied had the tax gone into effect.

To determine whether an excess benefit has been provided, the employer must determine a monthly excess amount, which is the excess of the cost of the coverage for the employee over an amount equal to 1/12 of the “annual limitation” for the year. The annual limitation in the first year the tax was applicable is $10,200 multiplied by the health cost adjustment percentage ($27,500 for coverage other than self-only coverage). The annual limitation amount was to be adjusted annually for inflation. The health cost adjustment percentage was 100 percent plus the excess of: (1) the percentage by which the per-employee cost for providing coverage under the Blue Cross/Blue Shield standard benefit option under the Federal Employees Health Benefits Plan for 2018 exceeds such cost for the plan year over (2) 55 percent.²

Notice 2015-16 outlined potential approaches for determining what constitutes “applicable coverage” that would be included in calculating the per-employee cost in order to determine whether the coverage is subject to the Cadillac tax. The rules were expected to exclude from the definition of applicable coverage employee after-tax contributions to HSAs and Archer MSAs, though employer contributions to these accounts (including salary reduction contributions) would be included in determining the cost of coverage for the employee. Salary reduction contributions to health FSAs, as well as employer flex contributions used for health FSAs, would also be included in calculating the cost of coverage.

The Treasury and IRS had not decided whether certain excepted benefits, such as dental and vision benefits, would be included in determining the cost of coverage.³

1.    IRC § 4980(a).

2.    IRC § 4980I(b)(C).

3.    Notice 2015-16, 2015-10 IRB 732.

Under the Affordable Care Act (ACA), the exclusion from gross income for amounts expended on medical care was expanded to include employer provided health coverage for any adult child of the taxpayer if the adult child has not attained the age of 27 as of the end of the taxable year. According to Notice 2010-38, the adult child does not have to be eligible to be claimed as a dependent for tax purposes for this income exclusion to apply.¹

If an employer’s accident and health plan continues to provide coverage pursuant to a collective bargaining agreement for an employee who is laid off, the value of the coverage is excluded from the gross income of the laid-off employee.² Terminated employees who receive medical coverage under a medical plan that is part of the former employer’s severance plan are considered to be employees for purposes of IRC Sections 105 and 106. Thus, an employer’s contributions toward medical care for employees are excludable from income under IRC Section 106.³ Otherwise, the exclusion is available only to active employees.

Full-time life insurance salespersons are considered employees if they are employees for Social Security purposes.⁴ Coverage for other commission salespersons is taxable income to the salespersons, unless an employer-employee relationship exists.⁵ In the case of shareholder-employees owning more than 2 percent of the stock of an S corporation, see Q 287.

Discrimination generally does not affect exclusion of the value of coverage. Even if a self-insured medical expense reimbursement plan discriminates in favor of highly compensated employees, the value of coverage is not taxable; only reimbursements are affected (Q 610).

Beginning in January 2012, The Affordable Care Act requires employers to report the cost of coverage under an employer-sponsored group health plan.

The fact that the cost of an employee’s health care benefits is shown on the employee’s Form W-2 does not mean that the benefits are taxable to the employee. There is nothing about the reporting requirement that causes or will cause excludable employer-provided health coverage to become taxable. The purpose of the reporting requirement is to provide employees useful and comparable consumer information on the cost of their health care coverage.

1.    IRC § 105(b), as amended by the Patient Protection and Affordable Care Act of 2010 and the Health Care and Education Reconciliation Act of 2010. Notice 2010-38, 2010-20 IRB 682.

2.    See Rev. Rul. 85-121, 1985-2 CB 57.

3.    Let. Rul. 9612008.

4.    IRC § 7701(a)(20).

5.    Rev. Rul. 56-400, 1956-2 CB 116; see also IRC § 3508.

Businesses with fewer than 25 full-time (and full-time equivalent) employees (“FTEs”) with average compensation of under $50,000 are eligible for a two-year tax credit for health insurance purchased for employees. Owners, their family members, and seasonal employees are not counted and premiums paid are not eligible for the credit. This tax credit, however, is temporary and could be claimed only for a maximum of six years.

All businesses, large and small, were required to retain their current insurance plan and not reduce benefits or materially increase employee costs in order to retain grandfathered status and be exempt from the new nondiscrimination rules for health insurance.

Employers without a grandfathered health insurance plan that provides benefits favoring highly compensated employees will be subject to a penalty of $100 per day per employee who is not highly compensated once the IRS announces that the new health insurance nondiscrimination rules are in effect.

Companies with no more than 49 full-time and FTE workers are less affected by the new rules because they are not subject to any penalties for not providing adequate affordable coverage. Businesses with 50 or more FTEs must offer coverage or pay a penalty. This penalty provides employers with 50 or more FTE employees an incentive to provide coverage and not force employees to purchase health insurance through the exchanges. The penalties may, however, be far less than the cost of health insurance, which is subsidized by the exchanges only for those earning less than 400 percent of the federal poverty level.