The IRS issued guidance on Feb. 18, 2015, providing temporary relief until June 30, 2015, from steep penalties for small employers and S-corps that have continued to use premium reimbursement arrangements to provide health coverage for some or all of their employees. Many small employers have not been aware that premium reimbursement arrangements were effectively disallowed by the IRS starting in 2014, and as a result have continued to use them. These arrangements, which have taken many forms, have been used by employers to provide certain employees with individual health insurance by reimbursing them for the cost of the premiums, rather than adopting a broad employer-sponsored plan for all employees.

In response to comments by taxpayers and practitioners, the IRS has provided transition relief so that small employers can come into compliance. Notice 2015-17 describes this relief, as well as answers a lot of questions about what arrangements will be considered premium reimbursement arrangements, subject to penalties going forward.

Who is a Small Employer?

An employer is defined as a “small employer” in 2014 and 2015 if during at least six months of 2013 (status determination for 2014) and in 2014 (status determination for 2015), the employer employed fewer than 50 full-time equivalent employees.

Note: This transition relief, unlike the relief from the Play or Pay penalties, does not apply to employers with between 50-99 FT/FTEs in 2014.

What is a Premium Reimbursement Arrangement?

The IRS reiterated its prior pronouncements regarding what practices will be considered a “premium reimbursement arrangement,” subject to a penalty tax under Code Section 4980D when the relief under Notice 2015-17 expires. A premium reimbursement arrangement is any arrangement whereby an employer pays for or reimburses an employee for the cost of health plan premiums of an individual plan. It does not matter whether the premium reimbursement is made to the employee on an after-tax or a pre-tax basis; regardless of its tax treatment, it will still be considered a group plan that fails the ACA requirements. Likewise it does not matter whether the reimbursement is made directly to the employee or to the insurer.

However, a mere increase in compensation, without a requirement that the employee spend it on health coverage or endorsement of a particular policy, form, or issuer of health insurance, will not be considered a “premium reimbursement arrangement.” The IRS went on to clarify that providing employees with information about the Marketplace or the premium tax is not an endorsement of a particular policy, form, or issuer of health insurance.

Small Employers – Planning for July 1, 2015, and Forward

Small employers who wish to provide health coverage for some or all of their employees must drop their premium reimbursement arrangement, effective June 30, 2015, and adopt one of the following choices: (i) obtain group coverage (through SHOP or the local market); (ii) not offer coverage and encourage employees to shop for (possibly subsidized) individual coverage; or (iii) same as (ii), only also adopt a general increase in pay for some or all employees, not tied to premium cost, to help with the expense of individual coverage.

Small Employers – Penalty Relief Until June 30, 2015

Small employers may use premium reimbursement arrangements through June 30, 2015, without triggering penalties under the ACA. Small employers who used a premium reimbursement arrangement in 2014 will not be subject to a penalty in connection with that plan for 2014. It does not appear that small employers must change the tax treatment of reimbursements made in 2014 or the first six months of 2015. Small employers must discontinue the premium reimbursements effective June 30, 2015, or risk incurring penalties.

S-Corp Premium Reimbursements to 2 Percent Shareholders – Relief through 2015

S-corps may reimburse the cost of premiums to employees who are 2 percent or more shareholders through Dec. 31, 2015, without triggering penalties under the ACA.  The amount reimbursed will be included in income, but the 2 percent shareholder-employee may deduct the amount of the premiums on their own returns. The IRS said in Notice 2015-17 that S-corps could rely on this relief for reimbursements to 2 percent shareholders until federal agencies issue further guidance, which may occur after 2015.


Premium reimbursement arrangements have been used by employers for decades as a mechanism to provide health insurance to certain employees. As far back as Rev. Rul. 61-146, the IRS held that an employer could reimburse or directly pay an employee’s individual health insurance premiums, on a tax-free basis. In addition, in light of the requirement under ACA that all individuals have health coverage, many small employers who are exempt from the employer mandate considered sending their employees to the Exchange where they could purchase subsidized coverage, with the employer assisting through an HRA or other arrangement. However, the IRS effectively prohibited this approach, and premium reimbursement arrangements in general, in Notice 2013-54.

The IRS held in Notice 2013-54 that premium reimbursement plans are group health plans, subject to the requirements of the ACA. For example, under the ACA, group health plans must cover at least preventive care and may not impose annual dollar limits on benefits. Because by their very nature, premium reimbursement arrangements could not conform to many of the market reforms under the ACA, they are subject to penalties that apply to group health plans under Code Section 4980D that fail to comply with the ACA. The penalty under Code Section 4980D for failing to comply with the requirements of the ACA is $100 a day, per covered employee.

Going forward, employers who have relied on these arrangements to attract certain employees or help employees with coverage will have to either shop for group coverage or explore alternative approaches for compensating employees for the cost of premiums.

If you have any questions, feel free to contact the attorney with whom you normally work.