By John Reichard, CQ HealthBeat Editor
May 28, 2014 -- Employers who have been giving their workers a lump sum of pre-tax money to buy health coverage won't be able to do so without facing stiff penalties because of the health care law, the Internal Revenue Service (IRS) has stated in recent days.
To avoid the penalties, employers can stop paying for health care or keep making the payments on a taxable basis. That option would result in companies and workers both facing higher tax payments.
Some consultants say the IRS could have resolved the matter differently, by permitting workers to use the tax-free employer contributions to buy individual coverage on the health law's insurance exchanges. That would have slowed what they say is an accelerating trend toward small employers dropping coverage.
A change in presidential administrations could overturn the current policy, they add.
Some small employers trying to help workers with medical expenses offer an insurance plan while others offer a sum of money intended to help workers pay their premiums.
The IRS policy is found in a May 13 question-and-answer document stating employers face a penalty of $36,500 per employee per year if they continue to make tax-free contributions to help workers buy their own plans.
The IRS document states "these employer payment plans are considered to be group health plans subject to the market reforms" of the health law (PL 111-148, PL 111-152).
The health law bars caps in insurance plans on annual benefit payouts. It also requires plans to provide certain preventive benefits without the enrollee having to pay out of pocket charges.
Because the employer payment plan arrangements don't comply with these requirements, the employers offering them will have to pay stiff penalties, the IRS says.
The tax collection agency's stance means that "an employee cannot purchase an insurance policy sold in the individual health insurance market with non-taxable contributions, period, exclamation point," says Christopher Condeluci, a former tax counsel at the Senate Finance Committee.
Condeluci, now a lawyer with the Venable LLP law firm, says the payment arrangements violate the annual limit prohibition because they are viewed as imposing a cap up to the cost of the individual market plan an employee purchases. Also, the arrangements "are not integrated with another group health plan that otherwise meets this new requirement."
Condeluci added that it appears certain employee pre-tax contributions can't be used to buy an individual market plan sold outside of the exchanges.
Rick Lindquist, president of Zane Benefits in Park City, Utah, predicted in an interview last week that 60 percent of the small businesses with fewer than 50 workers that provide health insurance will stop doing so within three years. Today, less than half of employers with less than 50 workers are paying at all for health coverage, he said.
Factors fueling that trend, experts say, include rising health costs stemming in part from new health law requirements, as well as the availability of generous federal subsidies for individuals to buy coverage on the exchanges.
But Lindquist, whose firm helps employers reimburse employees for individual health insurance costs, said small employers would jump at the chance to keep paying something for health care if those contributions were considered tax free and their workers could use them on the exchanges.
He predicted "there are going to be riots in the streets" when employees realize that many small employers otherwise willing to provide health care dollars are backing out because of the threat of stiff tax penalties.
"This conversation is just starting," he said. "I think it will be revisited. But, until it does, employers should ensure they design reimbursement arrangements in compliance with the current rules."
Condeluci says he's optimistic about a change "if the politics in Washington, D.C., change after the 2016 elections."
A change may be more likely if Republicans control all three branches of government, he said. But even with a Democratic president, it could occur after the individual insurance market has had time to adjust to the major changes it has undergone because of the health law, he added.
Neil Trautwein, vice president of the National Retail Federation, likens the odds of having Republicans running all branches to winning a trifecta at the race track—a bet he's not willing to make.
Linda Blumberg, an analyst with the left-leaning Urban Institute, doubts that changes permitting such tax-free contributions could be limited on Capitol Hill to small employers. "It's just a matter of do you want to unravel employer sponsored coverage," she said.
Instead of getting covered by the employer, the worker would have to pick a plan on exchanges, no simple matter given the exchange shopping experience so far under the health law, she noted.
Many people would be facing "enormous disruption," she said. Blumberg emphasized that she's not saying the tax treatment of employer contributions won't change some day. But she said if it happens, it's likely to involve a more fundamental examination of how tax incentives are allocated to purchase health care than the issues dealt with in the IRS document.