This article (updated November 6, 2014) discusses the Affordable Care Act's impact on more-than-two percent shareholders of S Corporations. Discussed is the ACA's impact on FICA and the IRC section 162(l)(5) self-employment health insurance premium deduction. This article also addresses the potential wide-ranging impact of new DOL Q&As.
The issue of reimbursing health care premiums for more-than-2% S corporation shareholders in the wake of the ACA was an issue we addressed briefly during the case studies at our August 22, 2014, Affordable Care Act (ACA) Seminar. Because this issue has sparked a number of questions, we wanted to follow-up with additional information.
Note: This area of the law is not well-defined and the IRS has not specifically addressed the issue. Instead, practitioners have been left to sort out the ACA fallout for these more-than-2% shareholders by reading and applying the relevant statutes and revenue rulings in light of known ACA requirements. The American Institute of Certified Public Accountants has requested formal guidance on the issue from the IRS. Until formal guidance is issued, we recommend advising your clients to err on the side of caution. It is also important to point out that the background law has not changed:
To thoroughly analyze this complex issue, a review of the applicable background law is necessary:
Taxation of Fringe Benefits Generally
Exclusion from Income for Employer-Provided Health Benefits Generally
Included as “Wages” for More-Than-2% Shareholder-Employees of S Corporation
I.R.C. §162(l) Above-the-Line Deduction
Note: If the accident and health insurance premiums are not paid directly by the S corporation or reimbursed to the employee by the S corporation and included in the 2-percent shareholder-employee’s gross income, a plan providing medical care coverage for the 2-percent shareholder-employee is not established by the S corporation and the 2-percent shareholder employee is not allowed the deduction under §162(l).
Although the health insurance premiums paid by an S corporation on behalf of its more-than-2 % shareholder-employees are included as “wages” for income tax purposes, the value of these premiums has long been excluded from “wages” for FICA purposes. IRS Announcement 92-16 clarified that accident and health payments “made under a plan to benefit employees” are exempt from FICA tax, pursuant to I.R.C. §3121(a), which states as follows:
(a) Wages. For purposes of this chapter, the term "wages" means all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash; except that such term shall not include—
(2) the amount of any payment (including any amount paid by an employer for insurance or annuities, or into a fund, to provide for any such payment) made to, or on behalf of, an employee or any of his dependents under a plan or system established by an employer which makes provision for his employees generally (or for his employees generally and their dependents) or for a class or classes of his employees (or for a class or classes of his employees and their dependents), on account of—
(B) medical or hospitalization expenses in connection with sickness or accident disability.
This statute thus exempts from FICA tax liability those payments “made to employees generally” “under a plan or system established by an employer” on account of “medical or hospitalization expenses…” Announcement 92-16 states, “For this exclusion to apply, the payments must be made under a plan or system for employees and their dependents generally or for a class (or classes) of employees and their dependents. Thus, whether amounts of this type are actually subject to social security or Medicare tax depends on whether in the particular case the taxpayer satisfies the requirements for the exclusion.”
The above background law has not changed. What has changed is the ability of S corporations to reimburse their employees (including more-than-2% shareholder employee) for health insurance premiums used to purchase an individual health insurance policy without running afoul of ACA market reforms. As detailed in the seminar and in this article, employer premium payment plans (used to purchase insurance other than employer-provided group health care insurance) are considered group health plans that violate the market reforms of the ACA, thus subjecting their sponsors to potential fines of up to $100 per day per employee per violation. That could amount to $36,500 per year per employee per violation.
Note: It is important to remember that if an employer (including an S corporation) has only one participant in a group health plan, ACA market reforms do not apply. Consequently, a single-employee S corporation may continue to reimburse a more-than-2% shareholder-employee for health insurance premiums as before. The amount is included in wages, an above-the-line deduction is allowed to the shareholder, and FICA need not be charged. If the company has more than one shareholder, but only one is reimbursed for insurance, that shareholder’s reimbursement may also be treated the same way.
As was discussed at the seminar, S corporations with more than one employee (and other small businesses) that have traditionally reimbursed their employees on a pre-tax basis for their individual health care premiums must now either (1) eliminate their health benefits entirely or (2) establish group health insurance coverage for their employees.
Note that if the S corporation chooses to offer group health insurance coverage to its employees, the taxation rules for that benefit as applied to more-than-2% shareholders have not changed. The health insurance premiums paid on behalf of more-than-2% S corporation shareholder-employees are deductible and reportable by the S corporation as wages, the payments are included in the shareholder’s wages for income tax purposes, and the benefits are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes.
But may an S corporation reimburse its S corporation shareholders for health insurance premiums outside of a group health plan? Do the same rules preventing this reimbursement to regular employees apply to S corporation shareholders?
The answer is that we do not know. The Departments have provided no guidance on this issue. We can only set forth what is known at this point (which is ever-changing).
Although they don't reference S corporations or their more-than-two percent shareholders at all (no guidance on this issue has done so), Department of Labor Q & A's released on November 6, 2014, raise concern that the act of reimbursing more-than-two-percent shareholders (outside of an employer-provided group health insurance arrangement) in the manner required under 2008-1 for a section 162(l) deduction may be viewed by the Department as establishing a group health plan subject to ACA market reforms. The Q & A at issue reads:
No. If the employer uses an arrangement that provides cash reimbursement for the purchase of an individual market policy, the employer's payment arrangement is part of a plan, fund, or other arrangement established or maintained for the purpose of providing medical care to employees, without regard to whether the employer treats the money as pre-tax or post-tax to the employee. Therefore, the arrangement is group health plan coverage within the meaning of Code section 9832(a), Employee Retirement Income Security Act (ERISA) section 733(a) and PHS Act section 2791(a), and is subject to the market reform provisions of the Affordable Care Act applicable to group health plans. Such employer health care arrangements cannot be integrated with individual market policies to satisfy the market reforms and, therefore, will violate PHS Act sections 2711 and 2713, among other provisions, which can trigger penalties such as excise taxes under section 4980D of the Code. Under the Departments' prior published guidance, the cash arrangement fails to comply with the market reforms because the cash payment cannot be integrated with an individual market policy.
Please let us know if you have any follow-up questions regarding this information. It is a thorny issue that will evolve. We will keep you informed of any further communication we receive concerning the issue. As we know, it is of great importance to you and your clients as you move forward to comply with the ACA provisions. We are hopeful that IRS will issue clarifying guidance in the near future.
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Tags: Agricultural Law Tax Affordable Care Act
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