I often read adviser comments online that reflect a common tax error about small business health plans and especially employer payments or reimbursements for individual health insurance. In some cases the same errant thinking even extends to tax treatment of uninsured health benefits.
Some advisers think that it is appropriate to account for employer-provided health insurance on an after-tax basis and that this alleviates ACA market reform penalties. This line of thinking lends credibility to the belief that tax penalties for non-compliant benefit plans can be alleviated at tax filing time simply by reclassifying the payments as employee after-tax compensation. This belief is wrong for two reasons:
- Employer-provided health benefits are always a tax-free benefit as described in Internal Revenue Code section 105(b). Classifying them as an after-tax benefit is simply an accounting error.
- IRS Notice 2013-54 makes it clear that classifying health benefits as after-tax does not alleviate the market reform penalties assessed under Internal Revenue Code section 4980D.
The appropriate approach to this common small business tax problem is to terminate, modify and/or amend employer health plans as appropriate and then, if desired, establish a permitted employer payment arrangement for health insurance that is not considered to be employer-provided health plan. Guidance is provided by the Department of Labor and codified as 29 C.F.R. §2510.3-1.
It appears to me that the error is caused by the fact that most small business advisers are either experts on taxes but not experts on employee benefit law, or vice versa. It appears to me that an understanding of this issue requires a working knowledge of employee benefit law in combination with small business tax law is required. Specifically, I see many examples where an adviser does not recognize the existence of a regulated employee benefit plan. This oversight could be costly if IRS enforces any of the several types of taxes and penalties that may apply to this situation.