Pardon me while I step up on my soapbox for a minute. A new TaxCoach member asked me a perfectly well-intentioned question on a webinar on Tuesday. It’s a question I get all the time, but it’s based on such pervasive misinformation that I just had to address it here in writing.
I had mentioned a marketing example of a client using a medical expense reimbursement plan to write off the cost of her daughter’s braces as a business expense (rather than a regular itemized deduction subject to the 10% floor on medical expenses). Our member then asked something to the effect of this: “Doesn’t the Affordable Care Act make medical expense reimbursement plans illegal and impose a $100/day fine on employers who use them?”
First, a little background. A Section 105 medical expense reimbursement plan, or MERP, is a long-established benefit plan dating back to 1954. The MERP lets an employer reimburse employees for any eligible medical expense they incur on behalf of themselves, their spouses, and their dependents. Typically, companies that adopt a MERP will buy group health insurance for their employees, then establish a “wraparound” MERP for expenses the underlying insurance doesn’t cover. Alternatively, some employers will “self-insure” and dispense with group insurance entirely, paying costs directly out of pocket and saving the cost of an insurance company’s profit and an agent’s commission.
A MERP can cover anything that would be deductible as “medical or dental” under Code Section 213. It can also cover any type of health insurance – individual policies, Medicare and “medigap” premiums, and even long-term care coverage. This is all well-established, black-letter law, and TaxCoach offers all sorts of resources you can use to understand these plans and implement them for your clients. There’s a terrific webinar explaining them all in the “TaxCoach University” section of the web site, under Expanded Topics heading called “MERPS: Everything You Wanted to Know About 105 Plans.” (Our MERP resources are just one of the reasons you need to be a TaxCoach member – if you’re not, visitwww.TaxCoachSystem.com for your 15-day free trial.)
Over the past few years, group health insurance has gotten more and more expensive. In fact, it has gotten so much more expensive than individual policies (because insurers can underwrite individual coverage) that some employers are the saying the heck with group coverage, dissolving their plans, and buying their employees individual plans. I can’t tell you how many TaxCoach members have approached me to say “My client wants to get rid of his group policy; can he set up a MERP and use it to reimburse employees for their individual policies?” And the answer, until recently, has been “have at it!” I’ve seen this sort of substitution cut plan costs in half or more. It really is amazing.
But now there’s a new rule that has upended that perfectly valid (and effective) strategy – courtesy of our newest BFF, the ACA. The ACA says, among other things, that health plans can no longer impose annual limits on benefits. This is part of what the law calls “market reform” provisions, and for most providers, it’s no big deal. Insurance companies have eliminated their caps on benefits, priced it accordingly, and called it a day.
Everything was fine until September 13, 2013, when the IRS issued Notice 2013-54. This is the most confusingly written piece of government “guidance” I’ve encountered in my entire career. And it takes direct aim that the individual premium reimbursement strategy I just outlined. The Notice says that if a MERP “wraps around” a complying group health insurance policy, it will be considered “integrated” into that compliant plan for purposes of meeting the market reform requirements. However, if an employer uses a MERP to reimburse an employee for the cost of individual coverage, that MERP will not be considered to meet the market reform requirements.
Now, this makes no logical sense at all. The IRS says that a using a MERP to reimburse the cost of individual coverage is treated as imposing an impermissible limit on benefits (specifically, the cost of the reimbursement). This is true even though the underlying individual health insurance policy being reimbursed has no annual limit on benefits! But even though the ACA itself runs over 2,400 pages, apparently there’s no room for common sense in the IRS interpretation.
Here’s where the worst of the misinformation comes in. Here’s where I get so frustrated I just want to punch someone. (And I’m not a violent guy, really. I’m a lover, not a fighter.)
Are you ready for it? You should probably sit down with a stiff drink in your hand before you read on. (Go ahead, we’ll wait.)
An employer who offers a plan that doesn’t meet the market reform act provisions is subject to an excise tax of “up to $100 per employee, per day.”
Somehow, the insurance industry, along with their willing accomplices in the financial press, have turned that tax into THE WORST THING THAT COULD EVER HAPPEN TO YOUR CLIENT. OH MY GOD, THE SKY IS FALLING AND IF YOU EVEN THINK OF SETTING UP A MERP, THE IRS WILL HOUND YOUR CLIENT INTO BANKRUPTCY AND THEY’LL SUE YOU TO WITHIN AN INCH OF YOUR LIFE!!!!! FORGET ABOUT THE EARTH GETTING HIT BY AN ASTEROID – YOU COULD BE LIABLE FOR $100 PER DAY PER EMPLOYEE!!!!!
I can’t tell you how many articles came out last summer, when the deadline for the new rules kicked into effect, warning everyone on the planet about that $100 per day disaster. But that warning has morphed into a rumor that MERPs in general are now “illegal,” and group health insurance agents (who get paid more to sell group policies than individual policies) have been only too happy to tell clients that if they adopt a plan, they’re just begging the IRS to fine them out of existence.
Here’s what the agents and press don’t tell you:
- The market reform provisions don’t apply to a single-employee plan. Are you taxed as a sole proprietor, with no employees? Want to set up a MERP, hire your spouse, and reimburse them for the cost of your family’s healthcare costs. Go for it – the ACA doesn’t change a single thing about it.
- It’s also still perfectly legal to offer a MERP that wraps around a group health insurance policy. Nothing about those wraparound plans has changed.
- It’s even perfectly legal to offer a premium reimbursement plan to pay for individual health insurance. (Except for subsidized policies from an exchange. No double dipping!) Those “premium reimbursement plans” aren’t “illegal” at all. They’re just subject to a penalty tax.
- If the IRS ever does come in and tell you your plan doesn’t comply, you have 30 days to correct the flaw before becoming subject to the tax. No harm, no foul.
- Now, let’s say you thumb your nose at the IRS and continue offering your noncompliant plan. You’re not ready to join a militia and take over federal property, are you? But you’re going to take a stand against Big Brother and tell the government “no.”
That $100 per day tax, that multiplies into a terrifying $36,500 per year, per employee? It’s capped, at just 10% of the cost of noncompliant benefits an employer provides. Pay $8,000 per year for your employee’s coverage? It’s capped at just $800. In fact, for larger employers, it’s even further capped at $500,000.
No employer will ever get caught owing a $36,500/employee tax. In fact, it may still make perfectly good financial sense for an employer to get rid of their group coverage, buy noncompliant individual policies, pay the damn 10% tax, and still come out ahead!
Now, I haven’t seen a single article in the popular financial press that mentions those limits. But I’ve seen plenty of scaremongering! And that scaremongering is what leads to questions like the one I got on the webinar Tuesday.
I hope I don’t come across as disrespectful to the dozens of members who have asked some variation of that question over the last two years. I don’t blame you at all. If I were hearing those same rumors, I would have some hard questions myself!
But please, for the love of God, if you hear that using a medical expense reimbursement plan (or any other strategy) is “illegal,” do your homework! Don’t let your clients take tax advice from sensationalist reporters or untrained health insurance agents looking to fatten their overrides and bonuses. Don’t let them be intimidated out of perfectly legal strategies that might save them a ton of money!
Got more questions? Join us on the last Tuesday of every month at 2PM Eastern for our TCU 999 Technical Q&A. (The next one is next week!) You’ll get to ask whatever sticky technical questions you like, and find 50 or more of your fellow TaxCoach members ready to give you the answers. It’s one of the most valuable perks of TaxCoach membership, and it can even help you sleep better. Talk to you then!