IRS Disallows Shifting Employee Health Coverage Burden to Exchanges


Certain employers hoped that they had discovered a way to "have their cake and eat it too". In response to the looming employer mandate for employers with 50 or more employees – the requirement to offer full - time employees group health plan coverage or else face penalties under the Affordable Care Act, - some creative Human Resource leaders had suggested that employers could send their employees to a health insurance exchange, while still offering those employees a tax-free contribution to assist with the exchange insurance premiums. This proposed "solution" would have theoretically permitted employers to save money by terminating their group health plan obligations, while still preserving the existing employer-based system's tax advantages, whereby employer contributions toward employees' coverage are not included as taxable income to workers. This would have provided employees with a variation of the current system, by offering a tax advantaged way to purchase replacement medical coverage through the exchange.

Through a question-and-answer issued on May 13, 2014, the IRS stated that this approach was not acceptable. Specifically, the IRS reasoned that such a pre-tax funding arrangement itself would be considered a "group health plan" under the Affordable Care Act and, therefore, the pre-tax funding arrangement would be required to comply with the Affordable Care Act's market reforms. So exposure to penalties would remain if the pre-tax funding arrangement was not compliant. In particular, failure to satisfy those market reforms would expose the employer to excise tax penalties of $100 per day per affected employee (i.e., $36,500 per year for every employee).

The IRS guidance does not allow such an incentive for large employers to drop employer-sponsored coverage. As expected, the Obama administration has expressed its agreement with and appreciation for the IRS' position, since the entire Affordable Care Act financial and administrative structure requires at its core the fundamental continuation of employer-based health insurance coverage.


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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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