Small employers (49 FTEs or fewer) are debating what to do about health care for their employees.  The news is out that premium increases may be much higher than expected for healthcare plans in 2014 and in the future. So many are considering dumping health care, letting their employees buy health plans on the Exchanges, and figuring out how to reimburse them. 

One method would to bump the salary up by the amount of the employer’s contribution to a healthcare plan.  In this case, the employee will recognize income and the employer will have to pay FICA and other taxes on that increased income, as well as not take advantage of any corresponding health premium deduction or credit.

Another alternative for the small employer, which would provide the opportunity for a deduction for the employer without having to recognize income to the employee, is the Section 105 plan.  

A Section 105 plan (named after the IRS code section 26 U.S. Code § 105 - Amounts received under accident and health plans) allows businesses to reimburse an employee for medical and insurance expenses incurred by the employee or his or her dependents. The most common type of Section 105 plan is a self-funded (i.e., self-insured) health plan, where the employer has chosen to self-fund health benefits. Section 105 plans are also frequently found in the form of Health Reimbursement Arrangements (HRAs) and possibly Health Reimbursement Plans. 

A Healthcare Reimbursement Plan (HRP) is a type of Section 105 self-insured medical reimbursement plan designed for premium reimbursement. Employers often use an HRP as the foundation of "pure" defined contribution health benefits. An HRP is similar to a business expense account for personal health insurance.

A businesses might also implement a Section 105 plan alongside a conventional employer-sponsored health insurance plan (to reimburse amounts not covered by insurance) or as a stand-alone medical reimbursement plan (to reimburse amounts for out-of-pocket health insurance premiums).

All reimbursements are 100% tax deductible by the businesses and its employees.  An employer may set the requirements of a Section 105 plan from probationary periods, hours worked per week, years of service worked and age requirements, etc.  And the employer could administer the plan itself, saving on administration fees.

However, employers are required to comply with the nondiscrimination provisions of Section 105 and cannot discriminate in favor of highly compensated employees under self-insured group health plan offerings or fully insured health plans as well.

Any reimbursement must be for qualified medical expenses as those defined in Section 213 of the Internal Revenue Code.  As a general rule, medical care includes amounts paid for diagnosis, cure, mitigation, treatment, or prevention of a disease and can cover health insurance premiums, dental care, vision care, etc. In addition, Section 105 plans can cover employee dependents as well for out-of-pocket health insurance costs. 

Also, Section 105 plans are covered under COBRA requirements.

For larger employers (50 FTE’s or more), a stand-alone Section 105 plan will not satisfy Obamacare requirements. The Department of Labor confirmed in a FAQ that stand-alone HRAs that are used to purchase individual coverage on an Exchange would not be considered “integrated”  with a healthcare plan and therefore generally would not meet the ACA’s annual limit prohibitions.  Under the rules, a Section 105 plan would have to meet the following rules to qualify under the ACA:  no limitation on the amount of payouts plan can make in the employee’s lifetime, provide preventive services at no cost to the employee, and provide essential health benefits as required under the law.  

Large employers should note that violation of the health care essentials incurs a penalty of $100 per employee per day.  However, a Section 105 plan may possibly be used in conjunction with current health plans to help satisfy the out-of-pocket cost limitations of Obamacare.

So the Section 105 plan as a vehicle for funding the costs of health care premiums is a small employer plan strategy that should be considered carefully with the employer’s insurance agent to determine how best to utilize and roll it out. 

Source:  ZaneBenefits 1/12/12, 12/2/13, 2/14/14, BusinessWeek 7/5/13, Cornell University