“Watcha gonna do?” – Tax professionals look at ACA compliance

How should a tax preparer handle suspected ACA penalties for small businesses?

This post is inspired by the recent frustration expressed by an accountant who is a Facebook friend. My friend commented on one of my posts that even after a substantial investment of his time to learn and apply provisions of the Affordable Care act, he is still “beyond confused”. After reading a post about one IRS form required by some small businesses this year. exclaimed “This form is completely ridiculous! ” I don’t disagree, but I always return to the position that as tax professionals we must deal with the law as it exists, not as we think it should be.

The common scenario

Imagine that it is April 1, 2016 and you are in the heat of tax season preparing 2015 returns. A small business client comes in to your office. This small business has only two employees besides the owner and modest tax liabilities. The husband owns the business and the wife is an employee. They use a part-time office assistant. You are aware of the new ACA tax rules but since this client does not sponsor their own health plan, this should not be an issue, right? As you look at the 2015 business records and engage in the usual fact-finding conversation it becomes evident:

The business pays a bit each month to the employee for the cost of her health insurance coverage under her spouse’s employer-sponsored health plan. This seems smart because the cost is less than if your client sponsored their own health plan. Your client wants to know how to report this for tax purposes.

Since the wife is an employee, they reimburse the cost of family out-of-pocket medical expenses though their health reimbursement arrangement that an insurance broker helped set up years ago. After all, the client reminds you, that tax deduction was one of the main reasons they incorporated their business in the first place.

The problem

You’ve taken enough ACA training courses that an internal alarm goes off. You realize that the client might be exposed to ACA tax liabilities for at least three of these issues. They are not aware of a required Form 1095 informational tax filing and are already past the die date. More significant from a liability perspective it that the transactions could result in an excise tax liability now approaching $50,000. Furthermore, the deadlines for provisions to mitigate the tax penalties have already passed.

Your options

What are your options?

  1. You can properly prepare the tax return as you always do, reporting the facts properly as intended under the self-assessment penalty provisions of the ACA. Your tax software produces a Form 8928 for the first time that indicates an additional tax liability is due in the amount of tens of thousands of dollars more than last year. You know this is completely unrealistic for multiple reasons.
  2. You can ignore the issue altogether and produce a tax return that looks much like last year’s tax return. We’ve read stories about business owners and professionals who ignore tax issues. It never ends well.
  3. You can report the transactions in your tax preparation software in a manner to avoid having the software produce a Form 8928 that indicates the excise taxes. The words “preparer liability” are ringing in your head.
  4. You can only hope the client does not ask “Why didn’t you tell me about this earlier!?” or make assertions that they are not liable for taxes that they did not know about. This is the part that really gets your blood pressure up. You can feel it happening just reading this article.*

Obviously, none of these are good options.

A better option: isolate and insulate

I suggest there is a better alternative and this alternative is the core of my own professional practice.

Here it is:

You should seek to immediately isolate the potential ACA liability and insulate yourself from its potential impact on the good relationship you have with your tax client. You simply say “I think we might have an issue here with the new ACA rules. Let’s bring in a specialist to handle that issue and we’ll focus on the rest of your return”. Any further discussion on the topic at this point simply works against you.

I actually learned to use this strategy effectively in the 1990s and early 2000s working with insurance brokers who did not want to bear the brunt of their client’s complaints about health insurance and never-ending rate increases, claim denials, and cuts in coverage. It was better for them to offer me as a messenger of bad news about the health plan (as in “kill the messenger” marketplace mentality) rather than risk their own valuable reputation. By outsourcing the health plan issues to me, the brokers actually increased their own profitability by not having to spend time on these issues and avoiding client resentment. These clients simply did not associate their insurance broker with the “bad news” health plan.

Specific strategies will evolve

At this point there are too many unanswered questions about IRS enforcement of ACA penalties for small business to address specific options for penalty abatement and relief.

I’m sure that there will be more posts here to follow on strategies to deal with 2015 ACA penalty issues for small businesses. But this first concept is by far the most important and the most valuable: If you hope to remain as the trusted tax adviser, you do not want to deal with it.

*For more blood pressure raising information, see my annotated bibliography on related topics.

Watchlist for tax preparers: 2015 small business health plans

2015 brought dramatic changes to the way that small business health benefits are handled for wage and income tax reporting purposes. Harsh new penalties now apply to small businesses who may still be unaware of the new rules. Until recently many accountants believed that we would see relief provisions to these laws since so many small employers (possibly more than 100,000) and accountants are unprepared for the severe tax consequences this year. Yet members of Congress remain unsympathetic to our situation and CMS is unlikely to take action. At this point it seems clear that if any relief is possible, it will be penalty abatement after tax returns are filed showing the additional amounts due.

The tax rule changes for small business health plans create more work for tax preparers. The first issue that tax preparers face is recognizing the specific health plans that might trigger additional taxes or reporting requirements. This post is designed to list buzzwords and phrases that might raise awareness that a small business health plan might be affected by the new tax treatment.

The largest tax issues are triggered by employer payments or reimbursements for the cost of uninsured medical expenses outside of an integrated employer-sponsored group health insurance plan. These may be called Medical Expense Reimbursement Plans (MERP) or Health Reimbursement Arrangements (HRA). A compliant plan is usually administered by an insurance company.  If an employer is paying these expenses directly, this is a pretty strong clue that the plan may not be in compliance. Employer payments for uninsured non-integrated health benefits must initially be reported on Form W2 and Form 1095B. Then later when the business tax return is filed than Form 2828 is added to the tax return to calculate the excise tax. Employers will be shocked to learn the size of these fines at $100 per employee per day.

Tax preparers should also be on the lookout for a second category oh health plans called “Section 105 plans” or “health expense allowance” plans that are disguises for arrangements where an employer pays for or reimburses the cost of individual health insurance. These also trigger the $100 per employee per day excise tax under IRC 4980D. The key here is to make a distinction between an employer-provided employee benefit plan (whether pre-tax or after tax makes no difference) and a payroll system payment accommodation for individual insurance. Any type of employer-sponsored employee benefit plan (such as described in section 105 of the Internal Revenue Code that incorporated individual health insurance is a problem under the ACA rules. In sharp contrast, an arrangement that is payroll payment accommodation is not a “group health plan” as defined by ACA and NOT an employee benefit plan is OK and does not trigger a penalty. The distinctions between an employee benefit plan and a payroll system accommodation are beyond the scope of this blog post but are covered in IRS Notice 2013-54 and 2015-17.

Finally, employer-paid contributions to a Health Savings Account (HSA) on behalf of an employee who was also a participant in a Flexible Spending Account (FSA) that included a carry-forward of benefits remaining from 2014 for either the employee or the employee’s spouse’s employer sponsored health plan. The HSA contribution is not allowed so the accounting error must be corrected, preferably before the W2 form is prepared.

Tax preparers who find these situations should be careful to document their work and communications. Always ask whether a plan document exists. Review it if possible or find a third party to review the plan. Consider that the size of the tax penalties is so large that it may trigger an Accuracy-Related Penalty Under IRC §§ 6662 in the large portion of small business tax returns. In almost all cases it makes sense for the business owner to address the underlying health plan problem in order to minimize tax penalties for the period past and prevent further future accrual of tax penalties.

Tax planning for small business excise tax penalties under IRC 4980D

Tax professionals are looking for the best way to approach clients in this environment of uncertainty surrounding new excise taxes for small business health plans. The excise tax affects two types of plans: 1) those that use individual health insurance, and 2) those that reimburse employee out-of-pocket expenses (often called an “HRA”). Those who say nothing could risk exposure to liability if the penalty stays as part of the law. Those who react to correct their health plans might wind up wasting time and money if the excise tax is removed. A CPA asked . I posted this message in response to an inquiry about a discussion on what defensive strategy I would suggest to a small business client The original discussion was in the NJ CPA forum but I thought that it might enjoy wider interest here.

I just saw that Kiplinger Tax Letter July 2, 2015 edition says “So if the Service does not grant relief, it’s a safe bet that taxwriters will do so”. So that seems like a citable source of opinion for offering a tax risk management plan. Based on that, we might discuss a three-pronged planning approach with our small business clients:

1) The probability that the Service will act proactively to amend Notice 2013-54 to prevent passage of Grassley/Boustany bill.

2) The probability of the Grassley/Boustany bill becoming law as proposed.

3) The likelihood that undocumented Health Reimbursement Arrangements won’t stand up to any examination and won’t be protected under any safe harbor or extension provisions.

So a risk management discussion might involve: a) accounting for employer-paid individual health insurance as a taxable bonus for now with the possibility of adjusting wages before the year end (no harm done), b) a review of health plan benefit plan documents (a smart precaution under any circumstances) and c) a plan to delay modification of HRA plan designs until clarification is available. 

The problem I see ahead with the proposed solution is that small group insurers will balk (they may withdraw products), employers with 50+ employees will complain at the discriminatory treatment and legislators will be scared about the public cost of more small business employers dumping employees onto the insurance exchanges if they pass legislation easing the path to this strategy.

More information is likely to follow. But let’s not forget that as the law reads today many small businesses are exposed to that $100 per employee per day excise tax that was considered necessary to maintain the integrity of ACA’s health care reform measures. And no matter what, take this opportunity to review and update your employee health plan documents.