Tax Question on Health Plans....

[Guest Durkin14]

Greetings. I am currently a Tax LLM Student, and I was wondering if under a plan where an employer pays the premiums on insurance for employees and the employer also pays the deductible required to be paid by the employee for hospital visits whether the employee can exclude from gross income the payment by the employer for the deductible. Wouldn't this be eligible for the 105 exclusion because its essentially reimbursement for medical expenses because to incur the cost of the deductible, the employee must have engaged in some medical services? On the other hand this seems to be a gain though too...Im so confused...anyone help me?

[Lori Friedman]

What an intriguing question. I'll take my best shot at answering it, and I'll be interested in reading other people's thoughts.

You've described a self-insured health benefit -- the employer uses its own funds to reimburse employees for certain medical expenses. There are two considerations:

First, are the employees required to substantiate their expenses by submitting invoices, receipts, or some other documents? The employer does need to verify that an employee paid out-of-pocket costs to satisfy the insurance deductible. If the employer simply writes a check to each employee every year, equal to the amount of the policy deductible, the payments would be included in the employee's gross income.

Second, is the benefit nondiscriminatory? If yes, the self-insured benefit isn't reported on Form W-2 and is excluded from the gross income of both the non-highly compensated and highly compensated employees. If no, the highly compensated employees pick up an excess benefit amount in their taxable income.

[401 Chaos]

I agree with Lori that there are substantiation and possible 105(h) discrimination issues but as a general rule this should be covered by 105.

What if instead of the employer paying the premiums and deductible the employer paid higher premiums for a policy with a low or no deductible. There would seem to be no issue with that, would there? It's really not that different from what is proposed.

Durkin 14, you say that it looks like there is a gain involved. If by that you mean that by paying the deductible the employer is paying more than before or more than most employers for health care, then I agree. But couldn't the same thing be said for an employer agreeing to alter the percentage of premiums paid? I guess what I'm saying is I just don't see an issue as to whether its excluded under 105.

[mbozek]

See IRS pub 502 P 18 for taxation of reimbursements

[GBurns]

What was described is an employer paid health insurance plan with a standard section 105 MERP (Medical Expense Reimbursement Plan) and is not unusual. As pointed out by Lori and 401 Chaos there are substantiation and discrimination issues to be careful of. For an explanation see Treas Regs 1.105-5 and 1.105-11 in particular. A Google search on "Section 105 MERP" will also get you documents and other explanations and applications e.g http://www.dpath.com/products/max105.asp http://www.eflexgroup.com/products/section105/sec105.asp

[Guest Durkin14]

I agree with the above analysis, but am troubled by Section 105 exclusion. The Section 105 exclusion applies solely to direct costs for medical care. This reimbursement is for the deductible associated for medical care, not directly for the medical care. Instead of the payment going to the doctor from the patient and the reimbursement going to the patient. The payment is going to the insurance company from the patient, and the reimbursement going to the patient. Does that make a difference? Thank you, you all.....You've been more than kind with regards to furthering my education....

[401 Chaos]

Seems you could make an argument that paying the deductible is "employer- provided coverage under an accident or health plan" under § 106(a) and thus excludible. I always get confused between 105 and 106 but I think if an employer can pay premiums there should be a way to pay deductibles too.

[GBurns]

A deductible is part of the cost of the medical care. If the insurance coverage provided 100% UCR then there might be no out of pocket or deductible, however, if to reduce costs and utilization cost sharing was introduced such as by providing 80/20 coverage, the employee would have 20% out of pocket or deductible. Having a deductible or co pay is only the result of sharing the cost of the medical care. The costs are caused by the medical care and are only there because expenses for medical care were incurred.

I have seen nothing in 105 that implies "direct costs" or direct payment to providers. If direct payment to service providers was the only thing allowed, then section 125 FSAs could not exist. FSAs only have tax free reimbursements because of the exclusion allowed by 105.

[Don Levit]

This scenario brings up another question. What if the deductible was $25,000 per family? Of that deductible, $10,000 is assumed by the employee and the following $15,000 is assumed by the employer. Would there be any discriminatory issues for those employees whose costs did not exceed $10,000 versus those whose costs were between $10,000 and $25,000?

Don Levit

[GBurns]

I compare this to an employer pay all plan where the employees get the coverage of their choice whether individual, individual and spouse or family coverage.

It is not discriminatory if 1 employee gets family coverage fully paid while the other gets only individual coverage, because that is what coverage they needed, not that 1 plan cost $280 and the other cost $780 per month.

I also would compare it to what happens in many plans, but is most visible in self-insured plans. Employee A does not go to the Dr even 1 time for the year and so incurs no claims, but Employee B has triple bypass surgery that failed and so followed up with a heart transplant for a total cost of $580,000.

It is not considered discriminatory that 1 employee got $580,000 in benefits while another got $0. They both got what was needed to meet their medical requirements.

However, in the scenario that Don gives, there could be a problem if this was only done for HCEs and not available to all participants. I do not think that it is the final amounts paid that would create a problem but more what is made available at the start of each plan year.

[Don Levit]

Let's toss this idea around a bit. With the $25,000 deductible, shared by the employee and employer, at $10,000 and $15,000 respectively, is there a way to provide "dividends" at the start of the next year for the lower claim users, from a portion of the significant premium savings, without being "discriminatory." For example, those having medical expenses between $10,000 and $25,000 get lower dividends.

Those incurring medical expenses of $10,000 or less, get higher dividends.

Don Levit

[GBurns]

By dividends I presume that you mean either an incentive to keep future claims low or a reward for having kept past claims low.

The problem is that what happens 1 year most likely will not be repeated in the next year by many, although it is easy to identify those who incurred large claims.

However, If you do identify those who have had or can be predicted to have large claims, such as those with diabetes, COPD, MS, cancer etc, and then use this info, this would/should create privacy, discrimination and ADA issues.

[Don Levit]

The dividends would not be guaranteed, and certainly would change from year to year, in the amount and who was to receive them.

What I am asking is would it be discriminatory to provide a low claims family, say, $1,000 in dividends and a high claims family, no dividends?

Would it be discriminatory to provide similar dividends for families with similar medical expenses, regardless of age, or premiums paid?

Does any one know of any court cases that could substantiate or disprove this practice?

Don Levit