Reimbursement of health insurance premiums for individual policies

[Guest pmetallic]

Can a 125 plan allow for reimbursement of insurance premiums for an individual who does not choose to participate in his employer's health plan? Instead he or she chooses to get their own policy.

Secondly, assume the individual does use the employer's health plan for himself or herself but gets an individual policy for his or her spouse and children. Can a 125 plan allow for reimbursement of those premiums?

[GBurns]

Generally NO. See Revenue Rulings 61-146 and 2002-3 etc.

Why "generally" because I do not know for sure what you mean by "reimbursement" and "Can a 125 plan allow for reimbursement of insurance premiums ". A 125 plan never allows for reimbursement of any kind, however, an FSA within a 125 plan could reimburse eligible expenses (not including other insurance premiums???).

[Guest moosegirl]

Rev Rul 61-146 provides that the Sec 106 exclusion applies to an employer's reimbusement of an employee for individual accident and health insurance premiums paid by the employee to an insurer if (1) the employer has an accident and health plan under which it permits such reimbursements and (2) any reimbursement is of premiums actually paid by the employee.

We usually establish a separate Sec 125 Plan for such cases.

Rev Rul 2002-3 states that if an employee's taxable salary is reduced for employer-provided health coverage, then no "reimbursement" is allowed when the employee later pays the premiums.

[GBurns]

moosegirl

A separate section 125 plan still would not allow such "reimbursement". Such reimbursement would be done through a section 105 medical expense reimbursement plan.

Why do you use a section 125 plan for this? Is the employee making a salary reduction or does the employee have some sort of choice that would have created a constructive receipt issue?

[KJohnson]

http://benefitslink.com/modperl/qa.cgi?db=qa_125&id=145

http://benefitslink.com/modperl/qa.cgi?db=qa_125&id=65

[g8r]

I guess I'll add my 2 (or 3 cents). The 61 revenue ruling allows an employer to reimburse an employee for outside coverage. This is done under 105. So, an employer could just pay for the outside coverage.

If an employee wants to pay for the coverage and do it through a cafeteria plan, then informally the IRS has indicated that this can be done with a separate premium payment account (i.e., the annual election is just to pay premiums and not any other medical expenses). The cafe regs seem to allow this - they just prohibit the reimbursement of premiums from a health FSA but state that you can pay premiums through the normal operation of the plan). The authority for this -- 125 generally can be used to provide any benefit that an employer could provide tax-free to exmployees unless the benefit is specifically prohibited (such as long-term care, etc.). And, the 61 reveunue ruling allows the employer to provide individual coverage on a tax-free basis.

One point not worth fighting -- if insurance premiums are medical expenses under 213, why can't they be reimbursed from a health FSA? The cafe regs prohibit this but I don't think the IRS has the authority to limit benefits that are otherwise permissible. As we saw with OTC expenses, if it's allowed under 213 it's allowed under the health FSA??? (I raised this issue with the IRS many years ago and didn't really pursue it).

So, let's say you set up a separate premium payment account for individual policies. The participant should be one of the people covered under the policy, otherwise you have an issue with the requirement that generally you can over cover employees.

But, there are "issues" to think about before allowing. As with a 401(k), amounts paid pre-tax by the employee become employer provided benefits - for the Code but not necessarily ERISA. The concerns are whether this policy is subject to HIPAA, COBRA, ERISA, 105 nondiscrimination? HIPAA may be the deal killer. If 2 employees get the same policy and it's now employer provided b/c it's paid through a 125 plan, can coverage be denied for the 3rd employee who wants the same policy or does HIPAA nondiscrimination prevent the denial of coverage even if the person is uninsurable???

Just some food for thought.

[GBurns]

Revenue Ruling 2002-3 pointed out that you cannot reimburse the premium that was deducted on pre-tax basis. The only way to have deducted premium on a pre-tax basis would be through a section 125 plan. Therefore the Rev Ruling is saying that you cannot reimburse premium that was deducted through a section 125 plan. If I remember correctly, Rev Ruling 2002-3 did state that 61-142 was distinguised meaning that it was a separate issue, facts and circumstances not related to this issue. 61-142 had no section 125 cafeteria plan or pre-tx deduction.

The IRS did say that premium could be reimbursed but through a separate account, but that was not through a section 125 cafeteria plan and not where there was any pre-tax deduction. The IRS has never said that premium could be reimbursed through a section 125 plan.

[g8r]

I agree that if the premium had already been paid on a pre-tax basis, then you can't get reimbursed for it on a pre-tax basis. That would be double dipping.

However, it is possible to pay individual premiums through a cafeteria plan. It could be structured like any other benefit paid for through the cafeteria plan. An individual can elect to reduce compensation for the "individual premium benefit" and then pursuant to Rev. Rul. 61-142, the employer could either reimburse the employee (the employee would have already paid the premium with after-tax dollars) or the employer could pay the premium directly to the insurer. In either case, the employee has effectively paid for the premium through the cafeteria plan on a pre-tax basis.

The reason it's allowed is because unless a benefit is specifically prohibited, a cafeteria plan can offer any benefit the employer could otherwise offer on a tax-free basis. Without going into the details, everyone will agree health coverage can be provided through a cafeteria plan, and reason is because an employer can provide it on a tax-free basis to employees (IRC 105). And, we know that individual health insurance premiums are medical expenses under 105 and Rev. Rul. 61-142 makes it clear that an employer can reimburse or pay the carrier on a tax-free basis. Thus, it's an allowable benefit under 125 and the IRS has infomally acknowledged this as long as it's strucutred as a separate benefit. An employee elects to have the indivdual policy paid pre-tax and should the employee decide to cancel the policy, there is a risk of loss b/c any amounts already contributed can't be used for any other benefits.

What has always bothered me is the fact that the IRS won't allow these to be treated in the same manner as other medical expenses that can be reimbursed under a health FSA. We know a health FSA can reimburse medical expenses under 213. Look at the list of medical expenses and you'll see insurance premiums.

I have no doubt that an employee can pay for individual policies through a cafeteria plan when it's structured as a separate benefit. It's the non-tax issues that concerns me.

[GBurns]

Just stop and think about it for even a second. If the premium is paid through a cafeteria plan it is paid pre-tax. There is no other purpose for the cafeteria plan.

A reading of 61-142 and the IRS statements on double dipping and other statements by the IRS regarding the reimbursement of individual or any premiums show no mention of the use of a cafeteria plan. The clear reason being that you cannot reimburse the premium if it was paid through a cafeteria plan.

The reason that "health coverage can be provided through a cafeteria plan, and reason is because an employer can provide it on a tax-free basis to employees " is NOT IRC 105 but IRC 106.

Where did you ever see that "the IRS has infomally acknowledged this as long as it's strucutred as a separate benefit"?

As the recent revenue ruling regarding OTC pointed out 213 only provides the definition of the expenses of medical care not the items themselves. The items in 213 are for 213. Section 213 is in Part 7 of the IRC and is titled "Additional Itemized Deductions for ...." whereas 105 and 125 are in Part 3 of the IRC which is titled "Items specifically exluded from Gross Income". Itemized deductions are taken on Schedule A and cannot be pre-taxed. Exclusions are pre-tax items which cannot be entered on Schedule A. Read the Revenue Ruling. Your faulty logic is the same faulty logic that is used by the promoters of the double dipping arrangements that led to Rev Ruings 2002-3 and 2002-80.

[KJohnson]

EBIA seems to believe that such premium reimbursement accounts are allowed in 125 Plans--See p. 104 in the "Green Binders". The links in my prior post also indicate that this can be accomplished. My understanding is that typically, either the employer reimburses the employee once the employee provides proof that he or she has purchased the insurance (post tax) or the employer pays the insurer chosen by the employee directly. The PRA requires separate langague in your 125 Plan and as mentioned above can be no double dipping

The real issues are HIPAA/COBRA/ERISA issues. Until there is further clarification (which will probably arise in the context of individual insurance being purchased through HRA's) you probably want to allow only HIPAA "limited scope" benefits to be offered through these accounts. As g8r points out if you allow the purchase of insurance to which HIPAA's non-discrimination provisions apply it would appear that you have big problems.

The individual policies are probably also covered by COBRA but will probably not be written to give COBRA rights. Finally you have SPD issues with regard to describing the benefits etc.

[g8r]

GBurns,

KJohnson stated what I was presuming was a given. I absolutely agree you can't get reimbursed for a premium if it was initially paid on a pre-tax basis (either already paid by the employer w/out an inclusion in income or if a deduction was taken for it).

So, let me explain how it works (in most cases). I go out and obtain a policy and pay the premiums. It's paid with after-tax dollars. Let's say it's $100 a month. I then elect to reduce my pay by $100/month through a separate "premium payment" benefit under my employer's cafeteria plan. So, I've paid the policy with after-tax dollars, reduced my pay through the cafeteria plan, and now the employer can reimburse me for this premium purusant to Rev. Rul. 61-142. The reimbursement is tax-free pursuant to Rev. Rul. 61-142. I have now paid the premium pre-tax (no double dipping) just like any other benefit under the cafeteria plan.

I don't have transcripts of seminars where the IRS has clearly stated that this is permissible (try ECFC). But, the only prohibition you see on this is through a health FSA (and even there it states these rules don't prevent the payment of expenses through the ordinary operation of the plan).

Put another way, 99% of the cafeteria plans allow employees to obtain health coverage on a pre-tax basis. Exactly where does it state that this coverage must be through a "group" health plan sponsored by the employer? The answer: it doesn't -- see Rev. Rul. 61-142.

[GBurns]

I think that you have misread 61-142 and grossly misunderstood the issue.61-142 does nothing similar to what you are implying. The reimbursement in 61-142 is from the employers assets and not from employee funds as your example entails.

If you have already paid the premium after tax and then Pre-tax the additional, Where does this pre-taxed amount go? The Treas Regs show that this MUST go to an FSA whether in or outside a section 125 plan and that the Proposed Treas Regs still apply. Similar thought is in the Notice etc re HRAs.

In addition, What medical expense would you use to reimburse the $100 that you are pre-taxing? You cannot use the $ 100 that you paid on an after tax basis since doing so would mean that there was no purpose to have paid it after tax in the first place. You cannot use the pre-taxed premium (see Rev Ruling 2002-3) so you would have to use other incurred medical expenses to trigger the reimbursement. If you have to use medical expenses NOT including the premium so you are now running the risk of "use it or lose it" if these other incurred ME do not amount to $1200 per year.

If you want to read all the comments made by the IRS just go to the EBIA website, they are all there.

Your last paragraph makes no sense since 61-142 has no connection to pre-taxing or section 125 not withstanding that 1962 was long before 1978.

[g8r]

Now I'm lost. And, I don't mean to beat this to death.

The entire concept of salary deferral cafe plans is to have employees contribute pre-tax. Then, when the benefit is obtained, it's tax free b/c of some code section permitting the "employer" to provide the benefit tax-free to employees. It's just like deferrals to a 401(k) plan -- they become "employer" contributions for purposes of the Code.

Maybe another to explain it is like this. Look at a DCAP offered through a cafeteria plan. In most plans, the employee pays the day care with after-tax dollars and gets reimbursed for the payments that have already been made. Now, using the logic in your prior message, exactly how does this work? Why would the employee pay the expense with after-tax dollars and then have a pre-tax contribution only to get reimbursed? IRC 129 only states that "employer" provided day care can be excluded from income.

Individual premium payments uses the same logic. 105/106 allows an employer to provide health coverage tax-free. I'm sure you'll agree. And, Rev. Rul. 61-142 states that an "employer" can provide individual coverage. I hope you agree with that. IRC 125 is just an exception to the doctrine of constructive receipt. My pre-tax dollars end up being converted to employer provided benefits. Anything an employer can provide tax-free can generally be offered through a cafeteria plan unless specifically excluded as a permissible benefit. And that's the key....105 and 106 are permissible benefits in a cafeteria plan. Thus, Rev. Rul. 61-142 could be applied to the cafeteria plan. I reduce my pay (just like I would with a DCAP), and I get reimbursed for expenses that I've paid with after-tax dollars.

Does this make more sense?

I no longer belong to ECFC so I don't know if I can access the old IRS comments but I'll try. And these are really old ... it goes back to when the proposed regs were issued stating you can't pay the premiums from the health FSA but you can do it through the normal operation of a cafeteria plan.

[g8r]

I did find some of the more current ECFC transcripts from August 2000. The issue relates to changes in status - and the example John Hickman raises is exactly what we're referring to. Although - I'm now not sure if it's 61-142 or 61-146. The actual issue as to whether it's allowed isn't discussed because that had already been resolved with the IRS years before this.

Hickman: Stepping back for a moment, back into the realm of the proposed change in status, proposed change in cost or coverage regs, I just want to give Harry a break and get Chris back in here. One arrangement that many employers offer to employees is what’s known as a premium reimbursement account. Now this is not a flexible spending arrangement but rather under Rev. Rule 61-146, an arrangement where the employee elects to have pre-tax salary reduction fund an individual health policy or an individual supplemental health policy for themselves. But its an individual policy, not an employer based policy. And the reason I give you that background, one of the change in cost of coverage provisions is that if there’s a change in the benefit package that is offered, the Employee can then modify or change their election to elect the new coverage. So the question is, in a premium reimbursement account arrangement where the employee not the employer has selected a particular insurance carrier, does the employee have the leeway to go out and change and pick up a similar supplemental plan? If they have one cancer plan can they pick up another cancer plan at will?

Keller: I think our intent when we wrote the addition of the benefit package option section was that those would be employer changes and not employee motivated changes. So I think under the regulations the answer is no. The employee deciding they want something else, you can’t say that that is the addition of a benefit package option. Its only when the employer offers something additional.

[GBurns]

It seems convenient that you disregard the many more recent comments from Harry Beker and others from the IRS addressing the exact point and are using an excerpt from an old statement taken out of context made by John Hickman claiming that "the example John Hickman raises is exactly what we're referring to". It is not. The issue has subsequently been clarified by IRS people (which John Hickman is not) in the many subsequent comments.

Regardless of what John Hickman says the Revenue Ruling does not address any pre-tax salary reduction. Just read it.

Also it would be helpful to cite where you excerpted the statement from.

[g8r]

I absolutely agree with you that the revenue ruling doesn't address pre-tax salary deferrals. But, then again, I don't recall seeing any mention in Code Sections 79, 105, 106, 129, etc. of providing these through pre-tax salary deferrals either. And, therein lies the crux of the disagreement. The 1961 rev. rul. is just a clarification of what 105/106 permit -- just like the recent ruling for OTC drugs. All of these revolve around the issue as to what benefits can be provided to employees on a tax-free (if the employer were to provide it at no cost to an employee). Once you've determined what benefits can be provided tax-free to employees at no cost, you then look at 125 which effectively converts employee money into employer money.

I also agree that what John Hickman says doesn't make it true. What I cited was from the August 2000 ECFC symposium and was just to illustrate that everyone presumes this can be done (b/c at prior conferences the issue was specifically addressed - I was there but don't have any transcripts to cite). Unfortunately, I haven't been to those conferences in quite some time so I haven't seen anything more current.

You stated that the IRS has subsequently clarified the issue and I'm curious as to where that is. More current transcripts from the ECFC symposiums are on their web site, but I couldn't find any mention of this topic. I also try to keep up with the ABA (American Bar) tax section employee benefit Q&As and don't recall any change in position or clarification of the issue. But, I'll admit I could have overlooked it. That's why I would be very interested in knowing where/when this was clarified by the IRS.

All I know for sure is the Treasury position that you can't reimburse individual premiums from a health FSA offered through a cafeteria plan. And, we know that doesn't make it correct either. But, I'm not arguing (at least right now) that the reg is invalid. Rather, the regulation doesn't address paying the premium outside of a health FSA but still within a cafeteria plan.

One final way of looking at this that might make it easier to understand my position. Go way back...before salary reduction cafeteria plans were around. Under 125, an employee isn't taxed merely b/c he or she has a right to get cash instead of a tax-free benefit. Pursuant to the 1961 ruling, I'm a generous employer. GBurns, if you want, I'll reimburse you for individual policies that you have paid (with after-tax dollars). But, if you don't want me to pay for the policy, I'll give you $500. Do you have to pay taxes on $500 even if you don't get the cash and I reimburse you for the premium you paid? Of course, my answer is you don't owe any taxes merely because you had the choice of receiving cash. Based on your reasoning, you would have to pay taxes.

I guess we can debate this 'till the cows come home. I know people are doing this (especially with respect to paying for COBRA premiums for coverage from a prior employer), and of course, that doesn't make it right. And, don't get me wrong... I'm not in favor of allowing the reimbursement of these policies. But, it's b/c of the non-tax issues.

[KJohnson]

Below is a link to comments where Harry Beker stated that PRA's could also be used to under a cafeteria plan to permit employees to pay premiums on a pre-tax basis (1) for a spouse's coverage under the group health plan sponsored by the spouse's employer; or (2) for an individual policy owned by the spouse

http://ebia.com/weekly/articles/2003/Caf030320IRS.jsp

[GBurns]

So there it is, one of the many that explain that you can pay for the spouses premium on a pre-tax basis, whether for a group or individual plan but none say that the employee can pre-tax for the employee (or anyone else) then get reimbursed. Note the last sentence re double-dipping. Double-dipping applies whether for spouse or for employee. In simple words if it is pre-taxed it cannot be reimbursed.

I think that the main reason why there is misundertsanding of the issues is the use of the term "reimbursement". When an employee has a pre-tax salary reduction under a section 125 POP plan and which amount is used to pay the health insurance premium, the term reimbursement should not be used. It is misleading because it implies, to many people, that it is the employee who "gets back" money whereas it really is the insurance company or service provider being "paid", the technical term for which is a reimbursement. The pre-tax salary reduction is used to reimburse (pay) the insurance company as premium not the employee for anything.

This POP treatment is different from the treatment of the pre-tax money that is taken from the employee for holding in an FSA ,which money is used to reimburse the employee for any after-tax eligible expenses incurred. Pre-tax reimbursing after-tax, no double-dipping. Note that insurance premiums whether pre-tax or after-tax cannot be run through an FSA anyhow.

[g8r]

Thanks KJohnson!! GBurns, when paying for spousal coverage, it probably will be a "reimbursement" arrangement similar to a health FSA. The spouse is paying for the coverage through an employer (with after-tax dollars) and the employee elects to reduce pay and get reimbursed for the premiums that the spouse paid.

I'm a little shocked by Harry's change of position regarding spousal insurance. The basis for saying this wasn't allowed is that a cafeteria plan has to be primarily for the benefit of employees, although others can benefit. Where family coverage is elected that's fine. But, I wonder if Harry would allow this premium to be paid if the only person covered was the spouse. Maybe his thinking is that if a spouse is covered then that will benefit the employee even though the employee isn't actually covered by the plan. Oh well.....

[GBurns]

No! Not similar to an FSA in any way. Note the words attributed to Mr. Beker and the wording of the Ruling "Mr. Beker mentioned two caveats, however: first, a health FSA cannot reimburse insurance premiums (any such reimbursement would need to be made through the POP portion of the cafeteria plan)".

However, I think that you finally at least understand that only premiums that were paid for with after-tax dollars could be eligible for reimbursement.