The new world of financial planning for small businesses

Financial planning has turned upside down this week for small business owners and most are still spinning to get a grip on the topic. Details of the new Republican road map will emerge over time but it t already clear that unprecedented opportunity to save money through proactive financial planning.

The most immediate areas of change and opportunity are:

  1. federal income taxes – significant tax reductions will be available for the most profitable businesses. These whose tax planning was restricted by the Alternate Minimum Tax will get a new lease on possible tax savings.
  2. employee benefits – fewer regulations will lead to more opportunity for creativity and savings. Freedom Benefits expects to re-introduce a wide range of cost-saving options that were retired with the passage of the Affordable Care Act in 2010.
  3. payroll taxes – adjustments will be needed for most firms and their employees. Fortunately today’s online tools reduce the cost while simultaneously improving the reliability of payroll services.

Tax free treatment of amounts received through health plans

The tax treatment of amounts received through accident and health plans is governed by Section 105 of the Internal Revenue Code. The treatment is relatively simple; the only common difficulty comes from the distinctions in treatment between insured and uninsured health plans. The tax code is reproduced below.

There is a minor typographical error in this section of the tax code. The text in (h)(7)(b) is missing a closing parentheses,

26 USC § 105 – Amounts received under accident and health plans

(a) Amounts attributable to employer contributions
Except as otherwise provided in this section, amounts received by an employee through accident or health insurance for personal injuries or sickness shall be included in gross income to the extent such amounts
(1) are attributable to contributions by the employer which were not includible in the gross income of the employee, or
(2) are paid by the employer.
(b) Amounts expended for medical care
Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include amounts referred to in subsection (a) if such amounts are paid, directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses incurred by him for the medical care (as defined in section 213(d)) of the taxpayer, his spouse, his dependents (as defined in section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof), and any child (as defined in section 152(f)(1)) of the taxpayer who as of the end of the taxable year has not attained age 27. Any child to whom section 152(e) applies shall be treated as a dependent of both parents for purposes of this subsection.
(c) Payments unrelated to absence from work
Gross income does not include amounts referred to in subsection (a) to the extent such amounts—
(1)constitute payment for the permanent loss or loss of use of a member or function of the body, or the permanent disfigurement, of the taxpayer, his spouse, or a dependent (as defined in section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof), and
(2)are computed with reference to the nature of the injury without regard to the period the employee is absent from work.
[(d) Repealed. Pub. L. 98–21, title I, § 122(b),Apr. 20, 1983, 97 Stat. 87]
(e) Accident and health plans
For purposes of this section and section 104—
(1)amounts received under an accident or health plan for employees, and
(2)amounts received from a sickness and disability fund for employees maintained under the law of a State or the District of Columbia,
shall be treated as amounts received through accident or health insurance.
(f) Rules for application of section 213
For purposes of section 213(a) (relating to medical, dental, etc., expenses) amounts excluded from gross income under subsection (c) or (d) shall not be considered as compensation (by insurance or otherwise) for expenses paid for medical care.
(g) Self-employed individual not considered an employee
For purposes of this section, the term “employee” does not include an individual who is an employee within the meaning of section 401(c)(1) (relating to self-employed individuals).
(h) Amount paid to highly compensated individuals under a discriminatory self-insured medical expense reimbursement plan
(1) In general
In the case of amounts paid to a highly compensated individual under a self-insured medical reimbursement plan which does not satisfy the requirements of paragraph (2) for a plan year, subsection (b) shall not apply to such amounts to the extent they constitute an excess reimbursement of such highly compensated individual.
(2) Prohibition of discrimination
A self-insured medical reimbursement plan satisfies the requirements of this paragraph only if—
(A)the plan does not discriminate in favor of highly compensated individuals as to eligibility to participate; and
(B)the benefits provided under the plan do not discriminate in favor of participants who are highly compensated individuals.
(3) Nondiscriminatory eligibility classifications
(A) In general
A self-insured medical reimbursement plan does not satisfy the requirements of subparagraph (A) of paragraph (2) unless such plan benefits—
(i)70 percent or more of all employees, or 80 percent or more of all the employees who are eligible to benefit under the plan if 70 percent or more of all employees are eligible to benefit under the plan; or
(ii)such employees as qualify under a classification set up by the employer and found by the Secretary not to be discriminatory in favor of highly compensated individuals.
(B) Exclusion of certain employees
For purposes of subparagraph (A), there may be excluded from consideration—
(i)employees who have not completed 3 years of service;
(ii)employees who have not attained age 25;
(iii)part-time or seasonal employees;
(iv)employees not included in the plan who are included in a unit of employees covered by an agreement between employee representatives and one or more employers which the Secretary finds to be a collective bargaining agreement, if accident and health benefits were the subject of good faith bargaining between such employee representatives and such employer or employers; and
(v)employees who are nonresident aliens and who receive no earned income (within the meaning of section 911(d)(2)) from the employer which constitutes income from sources within the United States (within the meaning of section 861(a)(3)).
(4) Nondiscriminatory benefits
A self-insured medical reimbursement plan does not meet the requirements of subparagraph (B) of paragraph (2) unless all benefits provided for participants who are highly compensated individuals are provided for all other participants.
(5) Highly compensated individual defined
For purposes of this subsection, the term “highly compensated individual” means an individual who is—
(A)one of the 5 highest paid officers,
(B)a shareholder who owns (with the application of section 318) more than 10 percent in value of the stock of the employer, or
(C)among the highest paid 25 percent of all employees (other than employees described in paragraph (3)(B) who are not participants).
(6) Self-insured medical reimbursement plan
The term “self-insured medical reimbursement plan” means a plan of an employer to reimburse employees for expenses referred to in subsection (b) for which reimbursement is not provided under a policy of accident and health insurance.
(7) Excess reimbursement of highly compensated individual
For purposes of this section, the excess reimbursement of a highly compensated individual which is attributable to a self-insured medical reimbursement plan is—
(A)in the case of a benefit available to highly compensated individuals but not to all other participants (or which otherwise fails to satisfy the requirements of paragraph (2)(B)), the amount reimbursed under the plan to the employee with respect to such benefit, and
(B)in the case of benefits (other than benefits described in subparagraph (A) paid to a highly compensated individual by a plan which fails to satisfy the requirements of paragraph (2), the total amount reimbursed to the highly compensated individual for the plan year multiplied by a fraction—
(i)the numerator of which is the total amount reimbursed to all participants who are highly compensated individuals under the plan for the plan year, and
(ii)the denominator of which is the total amount reimbursed to all employees under the plan for such plan year.
In determining the fraction under subparagraph (B), there shall not be taken into account any reimbursement which is attributable to a benefit described in subparagraph (A).
(8) Certain controlled groups, etc.
All employees who are treated as employed by a single employer under subsection (b), (c), or (m) of section 414 shall be treated as employed by a single employer for purposes of this section.
(9) Regulations
The Secretary shall prescribe such regulations as may be necessary to carry out the provisions of this section.
(10) Time of inclusion
Any amount paid for a plan year that is included in income by reason of this subsection shall be treated as received or accrued in the taxable year of the participant in which the plan year ends.
(i) Sick pay under Railroad Unemployment Insurance Act
Notwithstanding any other provision of law, gross income includes benefits paid under section 2(a) of the Railroad Unemployment Insurance Act for days of sickness; except to the extent such sickness (as determined in accordance with standards prescribed by the Railroad Retirement Board) is the result of on-the-job injury.
(j) Special rule for certain governmental plans
(1) In general
For purposes of subsection (b), amounts paid (directly or indirectly) to the taxpayer from an accident or health plan described in paragraph (2) shall not fail to be excluded from gross income solely because such plan, on or before January 1, 2008, provides for reimbursements of health care expenses of a deceased plan participant’s beneficiary.
(2) Plan described
An accident or health plan is described in this paragraph if such plan is funded by a medical trust that is established in connection with a public retirement system and that—
(A)has been authorized by a State legislature, or
(B)has received a favorable ruling from the Internal Revenue Service that the trust’s income is not includible in gross income under section 115.

Other resources:

Tax changes triggered by federal health reform law

 

A summary of tax issues related to employer-provided health benefits

Taxation of employer-provided health benefits is often a misunderstood topic especially in the years after implementation of the Affordable Care Act market reform provisions. Yet the fundamental tax treatment of health plans and health benefits has not changed in decades.

Four key factual issues now control the tax treatment of employer-provided health benefits under U.S. law:

  1. Whether the health benefit was provided through insurance or outside of insurance,
  2. If provided through insurance, whether the insurance was ACA compliant, exempted, or non-compliant,
  3. Whether the employer’s health plan meets legal requirements. (I used to write “whether an employer plan exists” but now presume that all employer-provided health benefits are part of a “plan” for tax purposes,
  4. Whether the benefit involved employee contributions as a salary reduction.

There are different components of tax law to consider that affect employer-provided health benefits including:

  1. Deductibility of the expense by the employer under IRC Section 162 (ordinary business expenses). Almost all employee health plan expenses do qualify as an ordinary tax-deductible business expense for the employer.
  2. Taxability of benefits to the employee, as determined by IRC Section 3121 (definition of wages). In the past almost all employer-provided health benefits were received tax-free by the employee but this is no longer presumed to be the case following implementation of the Affordable Care Act.
  3. Excise taxes imposed on non-compliant employer health plans under IRC Section 4980D. This is the new ‘hot issue’ for employers in 2014 following implementation of the Affordable Care Act. Many employer health plans are subject to a new 10% excise penalty, a few will be subject to much higher penalty amounts.
  4. Taxation for FICA and FUTA and state income taxes. This tax treatment may be different than the tax treatment for federal income taxes.

There are many resources available for tax advisers and business owners. A few are listed here:

IRS – Publication 15-B

IRS – Employer Health Care Arrangements

Freedom Benefits – Small business health plan compliance checklist 

Novak, Tony – Taxation of health insurance

Novak. Tony – 18 Things Small Businesses Must Know About Health Reimbursement Arrangements (HRAs)

 

How to calculate small business excise taxes under IRC 4980D

The preparation of 2015 small business tax returns will require the self-assessment and calculation of a new tax triggered by the Patient Protection and Affordable Care Act (PPACA). Beginning with the filing of the 2015 federal income tax return in early 2016 taxpayers and professional tax preparers are required to recognize when this tax applies and the calculate the appropriate excise tax for their small business clients under Section 4980D of the Internal Revenue Code.

Background

This section of tax law was introduced under the PPACA in 2010. This provision of the law became effective January 2014 but IRS issued a delay in enforcement applicable to small business employers that expired June 30, 2015. After that date, the excise tax must be self-assessed and included in the tax liability for the firm’s 2015 tax return. Larger employers were already subject to the excise tax penalty for 2014.

While several authors have published legal commentary on this section of PPACA, there are no known sources of practical help for tax practitioners who need to recognize and calculate the tax liability under this new section of the tax code.

No official estimates are published on the number of small businesses affected by this new provision of tax law but I roughly estimated it to be in the tens of thousands nationwide based on anecdotal indications of the portion of small business firms engaging in one of the two trigger mechanisms discussed below. If we add the number of firms in violation of other tax provisions for health plans then the number of affected taxpayers would likely rise much higher.

Recognizing the tax liability

The first step for the tax practitioner is recognizing when this tax applies. This posed a significant potential stumbling block because the tax return preparer may not recognize a non-compliant small business health plan.

There are two situations that trigger this tax: 1) payment of individual health insurance and 2) reimbursing out-of-pocket medical expenses under an arrangement that is not integrated with an employer-provided group health insurance policy. The tax preparer must be able to recognize each of these  situations that triggers a tax.

Neither of these triggers should create a penalty against one employee business. Small businesses are particularly vulnerable when they hire their first employee so the tax preparer should review 4980D issues with a self-employed client before they make a hiring decision. One person C corporation owners with high out-of-pocket medical costs, in particular, may be well-advised to consider using a contractor like a virtual assistant rather than hiring an employee. This alternate strategy may make it possible to continue using individual health insurance and a Health Reimbursement Arrangement without adverse consequence.

No change to taxation of underlying transactions

There is nothing in this tax code section or any other part of the PPACA that changes the underlying tax treatment of health insurance or uninsured health benefits as discussed in my other article here. Instead, the new law adds an additional layer of tax on top of existing law without changing the underlying law.

This is important point to consider because some tax practitioners think that by changing the tax treatment of the underlying transactions then the 4980D excise tax can be avoided. For example, some small business accountants report that they changed a the reimbursement for individual health insurance from pre-tax to after-tax bonus in an attempt to avoid triggering the excise tax. The proverbial “two wrongs do not make a right” applies here. In this example, the insurance reimbursement is now being reported improperly and the business is still not in compliance with 4980D.

Method of Calculation

There are two primary methods of assessing the excise tax: 1) the statutory tax of $100 per employee per day and, for qualifying employers, 2) a reduced penalty of 10% of the employer’s health care costs.

The larger excise tax penalty – $100 per employee per day – appears straight forward at first consideration, there are unresolved issues that may impair accurate calculation. Assuming that we are preparing the 2015 full year tax return and the violation existed for the entire year then the tax is $36,500 per employee. Presumably employees who did not participate in the employer health plan or reimbursement are exempted from the penalty but we have no authoritative proof.

Qualifying for the reduced penalty

Considering the potential for greatly reduced taxes, we presume there will be great interest in qualifying for the tax for unintentional violations.

The lesser excise tax penalty for unintentional violations of 10% of health care expense may be substantially lower, we have no guidance on the availability or applicability of this reduced penalty. Specifically, a self-assessment of the reduced penalty raises serious preparer questions. How can the violation be unintentional if the preparer recognizes it? And what if the violation continues past the tax filing deadline where a 4980D excise tax is self-assessed, wouldn’t that be prima facia evidence that the violation is not unintentional? How can the preparer know about the violation and simultaneously claim that the violation was unintentional?

This discussion is incomplete due to a lack of information at the time of the article’s publication.

Minimum penalty on audit

IRC 4980D (3)(a)(ii) has a minimum penalty of $2,500 if a de minimis violation is uncovered during audit. This appears to be a way for the Service to settle cases without arguing that a small unintentional violation reduces liability to almost nothing. This provision of the law appears to suggest that small business employers are potentially liable for even the smallest violations.

Avoiding preparer penalties

It seems clear that this new tax opens the door for substantial underpayment tax penalties for the small business employer and their tax preparers.  Preparers should take these additional steps during the preparation of a 2015 small business tax return to avoid substantial underpayment penalties:

1) Review the businesses health plan documents. In some cases the preparer may discover that required plan documents do not exist. Lack of required plan documents is a separate tax violation completely outside of the scope of this article. See my article here for other common problems with HRA documents and plan design.

2) Examine the integrated insurance policy. Is it a group type insurance? Is it issued in the name of the employer? Does it meet minimum requirements of a qualified plan under ACA?

3) Review individual health insurance payment transactions. If the business has any interaction with individual health insurance payment transactions, be certain that the IRS would not classify the transactions as an employer payment arrangement. Review the employment contract, if applicable, or documentation of bonuses that might be used to pay for individual insurance. If an employer is making or facilitating the payment of individual health insurance then make sure that the employee has the right to receive cash instead of insurance.

4) Consider whether the business meets the one employee business exemption for individual insurance or the church plan exemption. IRS has clarified that a business will not be penalized simply because individual health insurance was the only available option. This exemption some but not all of the requirements of the provisions of 4980D. While issued regulations address the case of the single employee business, they do not address the case where there is more than one employee but only one is eligible for health insurance. In this latter case, the only insurance option is still individual health insurance but current regulations do not clarify an exemption from the excise tax. Church health plans are also exempt from the excise tax.

Tax preparers who are not familiar with health insurance and employee benefits documents are well advised to obtain a professional review and opinion before making a determination of whether excise taxes under 4980D should be included on the small business tax return for 2015.

This discussion of tax preparer liability is incomplete because additional information was not available at the time of the article’s publication. Ideally, some tax preparer checklist or action framework could be developed to minimize the possibility of tax preparer liability.

Finally, because this is a new area of tax compliance for small businesses we should recognize that additional information is likely to emerge.

Changes to 2014-2015 tax penalties for small business health plans

On February 18, 2015 the IRS released Notice 2015-17 that delays some of the tax penalties included in the Affordable Care Act related to businesses that pay for or reimburse certain types of employee medical costs under conditions not allowed by the Affordable Care Act. The notice is important to businesses that paid or reimbursed the cost of individual health insurance in 2014 or those who reimbursed employees for out-of-pocket medical expenses outside of an insurance plan over the past year.

Freedom Benefits previously estimated that more than 1 million small businesses were in violation of one of more provisions of the law and the size of potential excise tax penalties (up to $36,500 per employee for 2014 alone) was enough to bankrupt many small firms. Under the IRS guidance issued today the application of penalties for small businesses is delayed until June 30, 2015. It is important for small businesses to review and update their non-compliant health plans over the next four months. Freedom Benefits offers a do-it-yourself compliance checklist or a professional review with sample plan documents that are intended to meet the new requirements.

In summary, the tax penalty for past violations in small business employee health plans is gone. Businesses must bring their health plans into compliance by June 30, 2015 in order to avoid tax penalties for 2015 an beyond.

What is a simple cafeteria plan?

Simple cafeteria plans were created as part of the Affordable Care Act of 2010 to make it easier for small businesses to meet the applicable tax requirements for this type of employee benefit plan.

To qualify for a simple cafeteria plan, the plan must meet all of the following criteria:

  1. Eligible Employer. To be an employer eligible to sponsor a simple cafeteria plan the employer must have employed an average of 100 or fewer employees on business days during either of the 2 preceding years.

Growing Employers. Special rules apply to a ‘growing employer’, in the event that its employee population exceeds 100 employees. The employer can continue to sponsor a simple cafeteria plan; however, in the year following a year in which the employer employs on average 200 or more employees on business days, the plan must be converted to a classic cafeteria plan.

Aggregation Rules. Related employers, as defined in IRC Section 52(a), Controlled Group of Corporations, or Section 52(b), Employees of Partnerships, Proprietorships, Etc., Which Are Under Common Control, must be combined in determining employer size. In addition, leased employees, as defined in IRC §§414(n) or (o), are counted in determining employer eligibility.

  1. Minimum eligibility and participation requirements. Simple cafeteria plans must meet minimum eligibility and participation requirements. Specifically, all employees who had at least 1,000 hours of service for the preceding plan year are eligible to participate. Each employee eligible to participate in the plan may, subject to terms and conditions applicable to all participants, elect any benefit available under the plan.

Excludable Employees. Certain employees may be excluded from the minimum eligibility and participation requirements; these include:

  • Employees who are under age 21;
  • Employees who have been employed for less than one year;
  • Employees covered by a collective bargaining agreement where health benefits have been the subject of good faith bargaining; and
  • Nonresident aliens with no U.S. source of income.
  1. Contribution requirement. The employer is required, without regard to whether a qualified employee makes any salary reduction contribution, to make a contribution to provide qualified benefits under the plan, on behalf of each qualified employee. Qualified employees are those employees who are neither highly compensated individuals or key employees, as defined by the cafeteria plan rules, and who are eligible to participate in the cafeteria plan.

There are two types of employer contributions, as follows:

  • The non-elective contribution is a uniform percent of compensation, but not less than 2% of the employee’s compensation for the plan year.
  • The matching contribution is an amount that equals or exceeds the lesser of:
  • Six percent of the employee’s compensation for the plan year; or
  • Twice the employee’s salary reduction contribution.

The contribution method selected must be the same for all qualified employees, and must be a true employer contribution, i.e., it cannot include a salary reduction contribution at all.

When a plan meets these criteria then it meets the non-discrimination requirements for a cafeteria plan. These requirements are less complex than the requirements imposed on other cafeteria benefit plans.

Other resources:

article: Taxation of small business health plans

Is a Form 5500 required? 

The Internal Revenue Service no longer requires the filing of a Form 5500 for small business benefit plans if the plan had fewer than 100 participants in the plan year. This change became effective in 2002.

Other resources:

IRS Notice 2002-24

article: “Taxation of small business health plans