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.

Five Strategies to Avoid Shared Responsibility Payments under the Affordable Care Act

If your business is worried about the potential cost of shared responsibility payments in 2015, you are not alone. Perhaps your company does not offer group health insurance now or your employee health plan does not meet the minimum essential coverage requirements under the Affordable Care Act (ACA). Now with only 90 days until the new tax penalty becomes effective, mid-sized employers are scrambling to find an affordable strategy. Transitional relief provisions help businesses in 2015, especially those with 50-99 employees. Employers in low margin industries like retail and food service have already begun testing these defensive cost control strategies so we now have a limited amount of experience to make these suggestions.

The basic underlying requirement is that beginning January 1, 2015 an employer with 100 or more full time employer’s must offer health insurance to avoid the shared responsibility payment. That health coverage must: a) be available to 70% of full time employees, b) meet minimum value rules, and c) cost less than 9.5% of an employees total household income. The rules get much tougher in 2016, encompassing employers with 50 or more employees and requiring coverage for 95% of employees and dependents. The penalty calculation formula also changes in 2016 resulting in a hike in the employer’s penalty.

The employer shared responsibility penalty is large enough to scare any small business owner. The minimum employer shared responsibility penalty for an employer who provides no health coverage in 2015 is $40,000 for a company with 100 employees. The penalty rises by $2,000 for each employee above that. In 2016 the penalty increases sharply due to the expiration of transition rules that are not discussed in this article. An alternate penalty is available if the employer provides some health coverage but this coverage fails one or more of the requirements of the law. In most cases the alternate penalty is lower than the regular employer shared responsibility payment.

This checklist below assumes that your goal is to reduce the maximum cost of ACA compliance to dollar amount that is less than the amount of the penalty1 and that you have already determined that your firm is large enough to trigger the shared responsibility payment requirement. It also assumes that the price of minimum value group health insurance is greater than the calculated tax penalty; that providing the plan as proposed by ACA would be the highest cost approach and is not practical for the employer.

Five strategies to consider:

  1. Offer employee health coverage at the maximum price of 9.5% of an employee’s total household income.2 Employers can stipulate and control the price of employee health coverage by combining insurance with a Health Reimbursement Arrangement (HRA) or Health Savings Account (HSA), or both. Early experience indicates that few employees will enroll in coverage at that highest price allowed under the law, especially in lower wage industries. The business is not penalized on the employees who are offered coverage but decline to enroll.
  2. Change to part time employees so that insurance is not required. Many firms have already adopted this approach by reducing work schedules below 30 hours per week.
  3. Use independent contractors to outsource tasks formerly handled by employees.
  4. Turn employees into their own self-employed business segments.
  5. Offer mini-med insurance. This is still allowed in most states until 2015 and is less expensive than Obamacare plans. It covers basic health expenses but not catastrophic or chronic treatment claims. This strategy preserves the employees’ rights to obtain primary coverage through the exchange. In this case the alternate penalty is $3,000 for each employee who receives a subsidy on the exchange. In most cases this will be substantially less than the regular shared responsibility payment.3

Business managers may conclude that none of the options are really attractive. We understand that implementation of the Affordable Care Act will take a toll on almost everyone except for those who receive subsidized coverage.

Finally, If you use any of these cost-saving approaches, it makes sense to pair your strategy with an employee health benefits consulting service. Make sure it is an independent service, not affiliated with the provider of your health insurance. find an independent adviser whose only interest is advising your employees on the best coverage options and how to pay for it. Remember that ACA implementation is challenging for everyone and it makes sense to provide someone who can bear the bulk of employee concerns with their changing coverage. This service costs less than 10% of the penalty (because not all of the employees actually use it) but goes a long way toward rebuilding employee financial confidence.

Footnotes

1When most employees earn less than 400% of federal poverty level, as is common in retail, food service, agriculture and other industries, it still makes sense to just pay the penalty. You’ll be doing your employees a huge financial favor because they will qualify for larger subsidies and, as a result, enjoy lower cost coverage through the exchange than the employer could ever offer. Many of the nation’s major employees have already selected this option and more are likely to follow.

2Since employers generally do not know an employees total household income, most employers will rely on a safe harbor provision where the calculation uses the employee’s income only. However, there is no prohibition on using the employee’s total household income as stated in the law. This is best accomplished by adopting a health care planning service as described in the past paragraph of the article.

3This cost savings concept is well illustrated in graphical format in an Employer Mandate Fact Sheet by Cigna.