Note: This should not be taken as legal or tax advice.
A common question we receive at Zane Benefits is: "Can I Offer a
Defined Contribution Health Plan to 1099 Contractors?"
The answer is Yes, with "but...". The "but..." is that unlike W-2 employees, 1099 contractors must report all reimbursements as income on their personal tax return.
Due to their flexibility, defined contribution health plans can be the ideal health benefits solution for 1099 contractors because:
- The 1099 contractors can only use the money on health insurance and medical expenses;
- Unused amounts remain with the company when the 1099 contractor is no longer working with the company;
- The plans help companies recruit and retain the most talented 1099 contractors.
Note: None of this should be taken as tax or legal advice
The federal government has guidelines for employers who want to contribute to an employee's individual health insurance premiums. Specifically, the employer must take special steps to avoid "employer endorsement" of the individual plans.
To avoid endorsement of individual health insurance plans, compliance includes the following restrictions on the actions of employers:
- Employers must not be involved in employees' decision to purchase individual health insurance, or their decision on which insurer or plan to use. They must not get involved in any negotiations with an insurance carrier over price or benefits of individual health insurance plans, and must not provide employees with claim forms or other materials related to their individual health insurance policies.
- Employers may not directly pay premiums on individual health insurance policies. They must not receive any compensation from an insurance carrier in connection with an employee's individual health insurance policy.
- Employers must not become involved in any claim dispute between an employee and an insurance carrier; all inquiries must be directed to the insurer.
To comply with point (1) above, while still making contributions to a defined contribution health plan that can reimburse for individual health insurance premiums, employers should follow these additional guidelines:
- Employers must not pressure employees to use the defined contribution to pay for individual insurance coverage.
- In addition to reimbursing for health insurance premiums, employers should also allow the use of funds for qualified medical expenses.
- Employers must limit their role to simply verifying that a qualified medical expense (such as an individual health insurance premium) was incurred, and then reimbursing such amount from the defined contribution.
See
Why Can't Employers Pay For Its Employees' Individual Health Insurance Plans? for more information.
Note: None of this should be taken as tax or legal advice
There are two major reasons an employer should never pay for its employee's individual health insurance plan:
- Federal Compliance Issues - Paying for Individual Health Insurance without a Defined Contribution Plan Causes the Employer to "Endorse" the Individual Health Insurance Plans
- Increased Tax Liability - Paying for Individual Health Insurance without a Defined Contribution Plan Causes the Payments to Become Taxable Income to the Employees
1. Federal Compliance Issues - Paying for Individual Health Insurance without a Defined Contribution Plan Causes the Employer to "Endorse" the Individual Health Insurance Plans
When an employer pays directly for an individual health insurance plan, they effectively endorse each employee's individual insurance plan as part of an
employer-sponsored group health benefit offering. In other words, according to federal law, the employer is treating the individual plan as part of an employee welfare benefit plan regulated by ERISA. Because most individual health insurance plans, do not meet minimum ERISA group plan requirements, the employer is out of compliance.
Separately, an employer is not allowed to know the details of employees HIPAA-protected medical expenses. Because most individual health insurance costs are based on an employee's health, the health insurance details must be HIPAA protected. When an employer pays for the individual policy, they can violate HIPAA-privacy requirements because they know the details of a HIPAA-protected employee expense.
An ERISA and HIPAA-compliant defined contribution health plan will ensure compliance with federal law.
2. Increased Tax Liability - Paying for Individual Health Insurance without a Defined Contribution Plan Causes the Payments to Become Taxable Income to the Employees
If an employer pays for employee's individual health insurance premiums without utilizing a defined contribution health plan, such payments must be reported as taxable income to the employees.
The IRS requires that legal plan documents be established in order for employees to deduct the individual health insurance premiums from taxable income on the annual W-2.
An IRS-compliant defined contribution health plan will ensure the tax deductibility of employee's individual health insurance premiums.
Note: None of this should be taken as tax or legal advice
Some common categories of reimbursable items include:
1. Health Insurance Premiums
2. Doctor Visits
3. Dental
4. Vision
5. Pharmacy
6. Hospital
7. Over the Counter Drugs (Prescription required)
Note: None of this should be taken as tax or legal advice Yes! With a
defined contribution health plan, an employer can give employees different contributions based on classes of employees. Federal regulations state that “a plan or issuer may treat participants as two or more distinct groups of similarly situated individuals if the distinction between or among the groups of participants is based on a bona fide employment-based classification consistent with the employer's usual business practices.”
To comply with these regulations, employee classes within the defined contribution health plan must:
- Be based on bona-fide business differences. These may include job categories, geographic location, part-time or full-time status, date of hire, etc.
- Treat all “similarly situated” employees equally. By creating classes based on genuine job categories, all employees within a class will be “similarly situated”.
- Not discriminate against unhealthy people. An employer cannot provide inferior benefits to specific individuals with adverse health conditions.
- Spell out the requirements for classes and benefits in the ERISA plan document.
If, upon audit, a defined contribution plan is found to not comply with these rules, then the employer must provide the same level of benefits to all employees, regardless of their class, from the time the plan was created to the date of the violation.
See
29 CFR §2590.702 for more information.
