When managing employee health benefits, employers might encounter situations where they inadvertently fail to deduct health premiums correctly or seek ways to support employees with health insurance costs. An employer can make you pay back missed health insurance premiums, either through pre-tax or after-tax contributions, or they may opt to cover the cost themselves.
This guide provides insights into correcting missed health premium deductions and understanding the compliance requirements for reimbursing employees for health insurance premiums.
Related: Gross pay vs Net pay: What’s the difference?
Correcting Missed Health Premium Deductions
In situations where employers discover that they have not deducted the correct elected employee salary reduction contribution amount through payroll, several options are available to rectify this mistake.
1. Employee Pre-Tax Contributions in Year Two for Year One Missed Contributions
Although the IRS has not issued formal guidance on this practice, employers can take employee pre-tax contributions in year two to address missed contributions from year one. This method is commonly applied when employees use the catch-up payment option after returning from leave, covering the full leave period even if it spans two plan years. Despite the lack of formal approval, this approach is generally considered low-risk.
Employers should note the following when using this method:
- No formal IRS approval exists, although issues are unlikely.
- For missed FSA contributions from year one, manual overrides may be necessary to exceed annual limits.
- If an employee terminates employment in year two before repaying the full missed contributions, the employer must either absorb the cost or seek repayment by check.
Employers should notify employees in advance about the additional withholding from their payroll in year two to address retroactive contributions. Since employees have already authorized the full withholding by making the original election to contribute, further approval is not required.
Sample Employee Communication
“During a recent system audit, we discovered that your [Year] payroll contributions for [Medical/Dental/Vision/FSA/etc.] were underfunded. We will correct this error by taking your missed contribution amounts through [an upcoming pay period or upcoming pay periods]. These corrective contributions will be [a one-time or per pay period] amount of [Amount] taken on a pre-tax basis. Please contact People Operations with any questions.”
2. Employee After-Tax Contributions in Year Two for Year One Missed Contributions
A more conservative approach involves requiring employees to make the missed contributions on an after-tax basis in year two, either through payroll or direct payment (e.g., check). This method is less advantageous tax-wise for both parties.
Employers should notify employees in advance about the additional withholding from their payroll in year two to address retroactive contributions. Employees have already authorized the full withholding by making the original election to contribute, so no further approval is needed.
Sample Employee Communication
“During a recent system audit, we discovered that your [Year] payroll contributions for [Medical/Dental/Vision/FSA/etc.] were underfunded. We will correct this error by taking your missed contribution amounts through [an upcoming pay period or upcoming pay periods]. These corrective contributions will be [a one-time or per pay period] amount of [Amount] taken on an after-tax basis. Please contact People Operations with any questions.”
3. Convert Missed Amounts to Employer Contributions
Employers may opt to forgive the missed employee contributions, effectively converting them to employer contributions as a corrective measure. This approach is costlier for the employer but simpler and less likely to cause employee relations issues.
Even with this method, affected employees must have had full elected coverage or available balance for reimbursement in the prior plan year despite the missed contributions. This approach ensures employees did not lose out on the benefits they elected due to the employer’s error.
Sample Employee Communication
“During a recent system audit, we discovered that your [Year] payroll contributions for [Medical/Dental/Vision/FSA/etc.] were underfunded. We will correct this error by forgiving your missed contributions. Despite the error on our end, you still had access to the full benefits you elected for the [Year] plan year. Please contact People Operations with any questions.”
Handling Terminated Employees
For employees who have terminated employment, payroll contributions are no longer an option. Employers can request direct repayment (e.g., by check), but recovering these amounts is unlikely. The best practice is to forgive the missed contributions as a corrective employer contribution.
Overcontributions: Returned as Taxable Income
Any over-withheld amounts should be returned to employees as standard taxable income, subject to withholding and payroll taxes. Corrections may be required for the employee’s Form W-2 if discovered after the end of the year.
Health Insurance Reimbursement Compliance
Small employers, particularly those with fewer than 50 full-time equivalent employees, need to be cautious about reimbursing employees for health insurance premiums to avoid hefty penalties.
Employer Penalties for Reimbursement
Under the Affordable Care Act (ACA), employers are prohibited from reimbursing or paying premiums for individual health policies on a pre-tax or post-tax basis. This prohibition applies to any form of payment or reimbursement, including through Section 125 or Section 105 plans. Violations result in a $100 per day ($36,500 per year) penalty per employee.
Legal Obligations and Taxable Wages
Small employers are not legally required to provide health insurance plans. However, if they choose to support employees, they can increase taxable wages to offset individual health coverage costs. The increase cannot be designated specifically as premium reimbursement, nor can it require employees to purchase health insurance to receive the wage increase. Doing so subjects the employer to penalties.
Other ACA Fees and Compliance
In addition to penalties for non-compliance with employer shared responsibility rules, the ACA imposes various fees that change annually. Employers offering opt-out payments to employees who waive coverage must meet specific requirements to remain compliant.
Health Reimbursement Arrangements (HRAs)
HRAs offer a compliant solution for employers to reimburse employees for health insurance without incurring penalties. These arrangements allow tax-free reimbursement for pre-qualified medical expenses within set parameters.
Employers can choose from various HRA plans:
- Qualified Small Employer HRA (QSEHRA): Designed for small employers, allowing reimbursement for health insurance and medical expenses.
- Individual Coverage HRA (ICHRA): Allows employees to purchase individual health insurance and get reimbursed by the employer.
- Excepted Benefit HRA (EBHRA): Provides limited reimbursement for certain benefits, excluding major medical coverage.
Conclusion
Employers must navigate complex rules to correct missed health premium deductions and comply with health insurance reimbursement regulations. By understanding the available correction options and adhering to ACA requirements, employers can effectively manage employee benefits while avoiding costly penalties. Utilizing HRAs can provide a flexible and compliant way to support employees’ health insurance needs.
