Reimbursement of Premiums from FSA

[Guest DMK]

Can an employee get reimbursements from his flexible spending account for after-tax premiums he paid for dependent coverage under his own employer's group health plan? I know that the IRS has taken the position that individual plan premiums cannot be paid from FSAs and that premiums for coverage through another employer cannot be paid using FSA funds. However, in looking at Prop. Reg. 1.125-2 Q&A 7(b)(4) it is not clear whether reimbursement of premiums for coverage with the employer sponsoring the FSA is also prohibited. (Assume for purposes of this inquiry that there are reasons that the employer does not allow premiums for dependent coverage to be paid on a pre-tax basis through a premium conversion component of a cafertia plan.) It seems that many have interpreted this reg to prevent reimbursement of premiums for unrelated coverage, but not for group coverage provided by the employer. Does anyone have any input or other guidance to which I should refer? Thanks.

[Guest JerseyGirl]

I can't imagine why the employer is prohibiting use of one of the most basic components of a 125 plan-- premium conversion! If it is for a reason such as only allowing certain employee's the ability to add dependents the the policy, wouldn't that cause discrimination issues?

I think you may need to clarify the situation before you can get any worthwhile feedback.

[Guest llerner]

Exactly. The employer should pre-tax via payroll deduction. Cafeteria component number one is premium conversion, the simplest to implement. No reimbursement required, pre-tax directly from payroll. Usually put into place if employees pay dependent premium then dcap and health care reimbursement plans (are the other components). One caveat is that the employee must not be a shareholder with more than 2% ownership in S corp to participate in any cafeteria plan component (or spouse if employed and not owner)

[g8r]

I'm sorry that I don't have the specific cite handy. But, there is a 1961 Revenue Ruling permitting an employer to pay for an employee's separate policy without an inclusion in income of the employee. The employer can either reimburse the employee (proof of payment of the premium by the employee would be required) or the employer can pay the premium directly to the insurer.

That ruling just deals with the exclusion from income of amounts an employer pays on behalf of an employee for health coverage. But, the thrust of IRC 125 is that it just provides for the exclusion of income where an employee has a choice of taxable comp (salary) or a tax-free benefit. You have to look for the sections of the code that permit tax-free benefits to be provided and then determine whether 125 specifically prohibits it in a cafeteria plan. Fortunately, there is no restriction on the payment of health insurance. Thus, the 1961 revenue ruling would allow an employee to exclude amounts for individual coverage. While I can argue with the IRS position on the payment of premiums from a health FSA, it has been acknowledged by the IRS that you can set up a separate premium payment account for the individual policy. Thus, an election is made for just that insurance. If the person drops the policy, then any unused amounts can't be used for other medical expenses.

Having stated that, it's not a very common provision, especially if the employer already offers group health coverage.

I can't rattle off all of the concerns but here are some reasons why it's probably not worth messing with:

1. You either have to pay the insurance co directly or handle it like a reimbursement account. If there are many employees, this is an administrative cost you need to be aware.

2. HIPPA is a big issue. Years ago some Blue Cross plans stopped allowing payments for individual policies to be paid by the employer. Remember that to the extent the employee excludes amounts through a cafeteria plan, it's an employer provided benefit. If 2 or more individuals elect the same individual policy and the employer is paying the premium (directly or through 125), you have HIPPA nondiscrimination rules. The insurance company might not be able to deny the 3rd person (who has cancer and is uninsurable) the coverage.

3. Again, it's employer provided so it's not clear if ERISA applies.

4. COBRA might apply.

[papogi]

DMK, 1.125-2 Q-7(b)(4) states “A health FSA may not treat participants’ premium payments for other health coverage as reimbursable expenses.” Sure, the example it then gives relates to coverage for dependents under a plan offered to an employee’s spouse, but the IRS statement is more encompassing than the example. Their statement says that a health FSA cannot reimburse premiums for other health coverage. “Other” health coverage means health coverage other than the health FSA (remember that even a health FSA is considered health coverage, since it is viewed as insurance itself). So, this would include individual health coverage purchased elsewhere, coverage under another employer’s plan, and even regular health coverage under the existing employer’s plan. To answer your question specifically, premiums paid after-tax to an employee’s employer to cover dependents cannot be reimbursed through the employee’s health FSA.

[Guest DMK]

papogi -- Thanks for answering the question. I read the regulation in the same manner as you but a colleague was trying to convince me otherwise.

[KJohnson]

This is what q8r was referencing:

All about premium reimbursements for individually-owned insurance

(Posted February 15, 1999)

Question 145: What types of insurance premiums are reimbursable through an "outside premium" provision in a flex plan? Can an outside insurance premium qualify if it is of the same type (e.g., health insurance) as that already being offered by the employer but the employee does not use the insurance offered by the employer? Is an outside insurance premium reimbursable if it is a policy of the employee's spouse but it is not insurance offered by the spouse's employer? Do you know of a good reference source for material on including an "outside premium" provision in a flex plan?

Answer: Let's take your questions one at a time:

What types of insurance premiums are reimbursable through an "outside premium" provision in a flex plan? Those types of insurance excludable from income under Code Section 106 - accident and health plans (including disability).

Can an outside insurance premium qualify if it is of the same type (e.g., health insurance) as that already being offered by the employer but the employee does not use the insurance offered by the employer? Answer: Only if it is part of the program of the employer to allow employees to obtain their own health insurance.

Is an outside insurance premium reimbursable if it is a policy of the employee's spouse but it is not insurance offered by the spouse's employer? Answer: This is tricky. I am not sure. If an employee is taking advantage of his employer's program which is, "go get your own", I am not sure if the spouse's individual policy would qualify. I can tell you that the spouse's EMPLOYER'S policy would NOT qualify.

Do you know of a good reference source for material on including an "outside premium" provision in a flex plan? Yes. Almost all that you will find (in terms of official guidance) is contained in Revenue Ruling 61-146 (yes, from 1961). I have provided it here for you:

Reimbursed health insurance premiums excludable from employees’ income

Rev. Rul. 61-146, 1961-2 CB 25.

Advice has been requested whether amounts paid by an employer, under the circumstances below, as his share of premiums for hospital and medical insurance for his employees are excludable from the gross income of the employees under section 106 of the Internal Revenue Code of 1954.

In the instant case, the employer pays a share of the premiums for hospital and medical insurance for his employees. For those employees who are covered by a group policy through their employment, the employer pays his share of the premium directly to the insurance company. For those employees who are not covered by the employer's group policy but have other types of hospital and medical insurance for which they pay the premiums directly to the insurers, the employer pays a part of such premiums upon proof that the insurance is in force and is being paid for by the employees.

To facilitate payment of his share of the premiums paid directly by the employees to the insurers, the employer uses the following methods:

(1) reimburses each employee directly once or twice a year for the employer’s share of the insurance premiums upon proof of prior payment of the premiums by the employee;

(2) issues to each employee a check payable to the particular employee's insurance company, the employee being obligated to turn over the check to the insurance company; or

(3) issues a check as in method (2) except the check is made payable jointly to the insurance company and the employee.

Section 106 of the Code provides that gross income does not include contributions by the employer to accident or health plans for compensation (through insurance or otherwise) to his employees for personal injuries or sickness.

Section 1.106-1 of the Income Tax Regulations provides that the employer may contribute to an accident or health plan either by paying the premium (or a portion of the premium) on a policy of accident or health insurance covering one or more of his employees, or by contributing to a separate trust or fund, which provides accident or health benefits directly or through insurance to one or more of his employees.

In this case it is clear that in method (2) the employer is actually paying accident or health insurance premiums directly to the insurer of the particular employee, utilizing the employee as his agent for the delivery of the checks to the insurer. Method (3) is not substantially different, inasmuch as the employee there is obligated to turn the checks over to the insurer and can in no event divert the payments to other uses. Although method (1) involves direct payment to the employee, in practical effect it does not differ from methods (2) or (3), since proof is required by the employer that hospital and medical insurance is in force for the employee and that premiums for the period involved have been paid by the employee and because the employer’s payment is stated to be in reimbursement for the employer’s share of the insurance premiums.

Under the circumstances of this case, it is held that the amounts paid by the employer under methods (2) or (3) above constitute payments of premium or portions of premiums on policies of accident or health insurance covering one or more employees within the meaning of section 1.106-1 of the regulations. Similarly, the payments under method (1) constitute employer payments of accident or health insurance premiums for employees if the payments are shown to be in reimbursement of premiums actually paid by the employees to the insurers. Accordingly, amounts paid as above are excludable from the gross income of the employees under section 106 of the Code.

Revenue Ruling 57-33, C.B. 1957-1, 303, holds that certain weekly payments made by employers direct to employees, pursuant to a union contract of employment, for the purpose of purchasing individual hospitalization and surgical insurance coverage, are "wages" for Federal employment tax purposes and are includible in the gross income of the employees.

Under the facts in that case, the employers had no accident or health plan of their own in effect and, with respect to the payments which they made direct to the employees, did not require an accounting either by the employees or the employees' union that the funds were expended in the acquisition of insurance coverage.

Revenue Ruling 57-33, accordingly, is distinguishable from the instant case."