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What if an employer has no employee beyond the owners' family?


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Much remarked on in our news is that the idea of an employer paying for its employee's individual health insurance is over.

But what if there is no group health insurance available for the employer to buy?

Under the New Jersey Small Employer Health Benefits Program, an employer cannot get a group contract unless it has at least one "real" employee. For that purpose, an employee "excludes a sole proprietor, a partner in a partnership[,] and a 2 percent S corporation shareholder[,] as well as immediate family members of such individuals."

If all of a corporation's employees are its shareholders and their children, must the business forego the tax advantages of employer-paid health insurance?

Or is there a way for the corporation to pay the premiums for each worker's individual health insurance, without tripping on the several prohibitions and penalties we've been reading about?

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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Great question and see my thread on the "Tax Free Premium Reimbursement- S corp loophole".

I think the bottom line is that the S corp payment or reimbursement of shareholder individual premiums are still deductible under 162(l) BUT probably violate the tenets of Notice 2013-54 and constitute an "employer payment plan" subjecting the S corp to the $100/day/person penalty under 4980D

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I think that Flyboyjohn's concern is worth considering, however the IRC has for years and years excluded 2%+ S corp shareholders from being "employees" for employee benefit purposes. Stock attribution also applies for tax reasons to the children, rendering them to be S corp shareholders too. However, ERISA Title I only excludes from the "employee" category the shareholders and their spouses, not the children. I think that until there's some specific pronouncement that shareholder/employees will be considered 'employees' for ACA '10 purposes and the restrictions it applies, the S corp could continue to pay for individual insurance premiums for coverage of the 2%+ S corp shareholders and spouses, but not the children. They're employees.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Flyboy - did you happen to see the last 2 posts in the thread you mention: http://benefitslink.com/boards/index.php?/topic/56028-tax-free-premium-reimbursement-s-corp-loophole/ Others of us disagree w/ your conclusion.

I remain of the opinion that 2% s-corp shareholders are entitled to the SE health insurance deduction on their personal 1040. But only if it is paid for with after-tax dollars by the s-corp and reported as taxable income on the individuals W-2. The deduction on 1040 is a dollar for dollar reduction of AGI, meaning it is effectively equivalent in individual income tax savings. Because the s-corp pays it with after-tax dollars, it avoids the health reform prohibition on pre-tax reimbursement of individual premiums. See post #5 in the linked thread for relevant quotes from Notices 2008-1 and 2013-54.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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The corporation has two shareholders, sisters, with an even 50% each. One of the shareholders has two children, both of whom are older than 21. Is mom's shares attributed to her adult sons?

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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I absolutely agree with the tax result, 162(l) is alive and well, no argument there.

My concern is with Notice 2013-54 which addresses "any arrangement" that pays or reimburses individual premiums and converts that "arrangement" into an employer payment plan subject to the $100/day/person penalty.

Reasonable men may differ.

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FGC - regarding your attribution question, from the few articles I looked at that cite the Code, it appears that Section 318 governs for determining who is a 2% s-corp shareholder. So the answer would appear to be yes, it's attributed to the adult sons. 318 does not appear to restrict it to, for example, minor children.

My concern is with Notice 2013-54 which addresses "any arrangement" that pays or reimburses individual premiums and converts that "arrangement" into an employer payment plan subject to the $100/day/person penalty.

Your concern is specifically addressed in the notice: "An employer payment plan, as the term is used in this notice, does not include an employer-sponsored arrangement under which an employee may choose either cash or an after-tax amount to be applied toward health coverage." (Also, the exact phrase "any arrangement" does not occur in the Notice; perhaps you're citing an article which was less than precise in its quotation of the Notice?)

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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ERISA section 732(a) states: "The requirements of this part (other than section 711 [mothers and newborns]) shall not apply to any group health plan (and group health insurance coverage offered in connection with a group health plan) for any plan year if, on the first day of such plan year, such plan has less than 2 participants who are current employees."

Should "employees" be interpreted to follow the idea in 29 C.F.R. 2510.3-3(b) that a plan in which only business owners participate is a plan without employees?

If the only thing an S corporation does is pay the individual health insurance premiums of the corporation's two shareholders (and there is no employee beyond the shareholders), do the Public Health Service Act market reforms apply?

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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If one imagines that a client might handle an ambiguity about whether the market-reform provisions apply by taking some risks ....

How likely is it that whichever arm of the Government that is supposed to impose the penalties would (or even could) detect the non-compliance?

Is there anything about the S corporation's tax-reporting to its shareholders or in a shareholder's tax return that claims the IRC 162(l) deduction that would show that the payments violated the market-reform provisions?

Is there anything in other reporting that would show that the payments violated the market-reform provisions?

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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If I worked for IRS here's how I would do it:

Flag all 2014 and later 1040s claiming a 162(l) deduction.

Send a computer generated letter from the Service Center asking whether the deduction was based on insurance premiums paid under a group plan or under an individual health insurance policy.

If the answer came back "individual policy" bingo, jackpot, send bill for $36,500

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But even if an individual's tax return claimed the IRC 162(l) deduction and the individual confirms that the payment was for a non-group contract, isn't it at least possible that the individual paid the premium from her resources (other than causing the corporation to pay the insurer)?

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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In the S corp scenario the corp MUST pay or reimburse the premium and add it to the W-2 in order for the shareholder to get the 162(l) deduction.

But you're right, my hypothetical letter from IRS should also say "...and if the premium was paid or reimbursed by your S corporation employer..."

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Flyboyjohn, thank you for the useful information. (I freely admit not knowing this small-business tax rule because it's never before come up in my work as an employee-benefits lawyer.)

Returning to the not-so-hypothetical situation I described, New Jersey law precludes the S corporation from buying group health insurance because the corporation's ONLY employees are its two 50% shareholder-employees. (The shareholders decided not to try employing either of the two sons.) And although interpretations of you, J Simmons, and masteff differ somewhat, the corporation's payment for individual health insurance bears at least some risk of incurring the $36,500-per-year excise tax.

Suppose the corporation conditions its payment of each individual health insurance premium on the non-violation of the market-reforms rule, with a legally enforceable right to a repayment (with interest) from each shareholder if it is found that the corporation's payment otherwise would violate the market-reforms rule. Would those terms establish the non-violation of the market-reforms rule?

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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I don't think the repayment agreement would get them out of the penalty (wouldn't they just be paying themselves back anyway?).

But, given the murkiness of the issue (I could certainly be wrong and the other commenters may be correct) and given the fact that until this issue is clarified 99.99% of S corps will undoubtedly continue to pay shareholder premiums and shareholders will continue to take the 162(l) deduction I would have no problem advising the client to "go for it".

Also remember that the 4980D penalty has caps that in this case would be far less than the $100/day/person maximum.

Our discussion on this bulletin board has been more in the way of an intellectual "what if" undertaking

and not meant to translate into real life practical advice to your client.

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Would those terms establish the non-violation of the market-reforms rule?

So here's something Flyboyjohn and I can agree on... I say no also. If it were found to be in violation, one of the rules that would be violated is the one on annual dollar limits. Given how the Service is on fixing other things that lap from one year to another, I would not expect them to be happy w/ a repayment happening a year or two from now to fix a violation in this year.

---------------------------

I've been re-reading Notice 2008-1 and Rev Rul 91-26. I encourage both of you review those against the IRS's statement in Notice 2013-54 in section II.B. Specifically: "Individual employers may establish payroll practices of forwarding post-tax employee wages to a health insurance issuer at the direction of an employee without establishing a group health plan, if the standards of the DOL’s regulation at 29 C.F.R. §2510.3-1(j) are met." Such a payroll practice is completely compatible with Example 3 in Notice 2008-1. http://www.irs.gov/pub/irs-drop/n-08-01.pdf

If nothing else, I think if you combine that payroll practice from 2013-54 with Example 3 from 2008-1, then you fully bypass the risk.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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I don't think it's a stretch to think the IRS will say an S corp payment of shareholder premiums which get added to the W-2 and then deducted on the 1040 would be considered for all practical purposes "pre-tax".

Remember the S corp doesn't withhold any income or FICA taxes from the payments and essentially just passes the deduction thru to the shareholder.

Not that it matters much but I'm not alone in my concern and have found other commentators positing the same issue.

Hopefully I'm wrong and the IRS is going to let this "loophole" go on forever (can you envision S corps giving all of their uppity-ups 2% of the stock to allow them to continue to enjoy tax free health insurance?)

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Again, thank you for the helpful observations.

I recognize all too keenly that I alone am responsible for how I advise a client.

The challenge is that I can't fail to inform my client about the risk that payments might violate the market-reforms rule and expose the corporation to an excise tax. Yet once I tell them, they'll expect my recommendation about how to remove the uncertainty. They won't like hearing that the expense of seeking a ruling might cost them more than the value of the tax deductions. Not getting a ruling means that two decent businesspeople, who could not have harmed anyone, remain exposed to liabilities. As a lawyer, I must put the problem to the client's choice; but I can choose to give them full-picture information, and empathize.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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I don't think it's a stretch to think the IRS will say an S corp payment of shareholder premiums which get added to the W-2 and then deducted on the 1040 would be considered for all practical purposes "pre-tax".

I am not just speculating. The IRS said it is not pre-tax in Rev Rul 91-26. The IRS explicitly states that the premiums are disallowed "pre-tax" treatment under Section 106. This means the premiums are after-tax dollars.

http://bradfordtaxinstitute.com/Endnotes/Rev_Rul_91-26.pdf

"A and B may not exclude the cost of the premiums from their gross income under section 106, but must include the cost of the premiums in gross income under section 61 (a). Provided all the requirements of section 162 (1) are met, however, A and B may deduct the cost of the premiums to the extent provided by section 162 (1)."

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Maybe I haven't been clear that I agree 100% with your position on the income tax treatment which remains full deductability of S corp shareholder premiums under 162(l).

My concerns center solely on whether the IRS will (in the future) expand the underlying theme of Notice 2013-54 (that premiums for individual health insurance can't ever enjoy tax free treatment) to encompass the S corp shareholder situation.

I think that's where they're headed but agree they're not there yet.

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My concerns center solely on whether the IRS will (in the future) expand the underlying theme of Notice 2013-54 (that premiums for individual health insurance can't ever enjoy tax free treatment) to encompass the S corp shareholder situation.

No. You haven't been clear.

Given that Fiduciary Guidance Counsel is asking for relevant and practical advice for a client's current situation, going forward, I would like to request that you, please, make a better effort to fully and clearly disclose what part of your statement is what you think the current state of the rules and regulations are and what part is your speculation about what you think the IRS might try to do at some unspecified future point in time.

In the meantime, based on his postings, you quite possibly have convinced Fiduciary Guidance Counsel that he should avoid a course of action which you just now conceded is a legitimate current course of action.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Again, thanks for the trove of information, which is a great help.

If the client's issue doesn't resolve itself by other means, I'll present all of the possible interpretations, with my own detailed analysis of the merits and weaknesses of each. A risk decision always is for the client.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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  • 5 months later...

The Internal Revenue Service's Notice 2015-17 in its Q&A 2 states some non-enforcement relief.

It also states: "If an S corporation maintains more than one such arrangement [to pay for individual health insurance premiums] for different employees (whether or not 2-percent shareholder-employees) ... all such arrangements are treated as a single arrangement covering more than one employee so that the exception in [internal Revenue] Code section 9831(a)(2) does not apply."

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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