Physician practices and other businesses that employ defined contribution health strategies to allow their employees to purchase individual health insurance policies could be in for an unwelcome and costly surprise on January 1, 2014, when more provisions of the Affordable Care Act (ACA) go into effect.

The Internal Revenue Service (IRS) released Notice 2013-54 in September, which states that certain health reimbursement arrangements (HRA) that employers have used in the past to implement defined contribution strategies do not currently comply with the ACA. HRAs have annual or lifetime dollar limits, which generally are not permissible under the ACA. Of particular interest is the outright prohibition of so-called “employer pay-plans” by Notice 2013-54.

“Many medical practices reimburse employees for premiums paid for individual, or non-group, health insurance policies or they pay these premiums directly on an employee’s behalf. These types of individual health insurance policies frequently are purchased by professionals through their relevant trade associations, such as the Medical Association of the State of Alabama (MASA),” says attorney Jay Maples of Sirote & Permutt, PC in Birmingham. “These arrangements – ‘employer pay plans’ – have always been considered group health plans by the IRS and the Department of Labor. In the past, this had little significance other than the concern about whether the reimbursement or payment was exempt from an employee’s income.”

Beginning January 1, 2014, the ACA prohibits almost all annual or lifetime limits on group health plans. “By their very nature, these plans have annual limits - the amount that the employer will reimburse for expenses or pay for insurance premiums,” he adds. “Therefore, if an employer continues these types of arrangements after December 31, 2013, the employer can be subject to penalties of $100 per day per affected employee.

Maples points out that physicians still can purchase one of these individual health insurance plans, but in order to get the benefit pre-tax they would have to take a deduction on their individual income tax returns. “It would have to be a Schedule A deduction, however, which is subject to a 10 percent Adjusted Gross Income threshold. Most physicians can’t get over that hurdle,” he says.

Employers should check with their attorneys to make sure they are in compliance with these new rules before they are hit with possible penalties, Maples says. “We are advising our physician practice group clients to terminate these types of arrangements prior to January 1, 2014, or consider electing to be taxed as an S corporation. This can help them work around the problem for shareholders who are also employees,” he says.

There are also issues with respect to HRAs that just reimburse an employee for medical expenses. Notice 2013-54 requires that HRAs be integrated with a group health plan and provides very specific rules to ensure that a plan is integrated. Except for retiree-only HRAs, stand-alone HRA plans are no longer permitted.

Notice 2013-54 also points out that health flexible spending accounts (FSA) offered as part of a cafeteria plan must be designed as “excepted” benefits through which the employer must provide other group health coverage. Employer contributions to the health FSAs must be at or below $500 or not more than a 100 percent match of employee contributions.

How likely is it that physician practices will be blind-sided by this new guidance under the ACA? “I think it is highly likely that some practices will miss this change and be penalized,” Maples says. “Many have been participating in a HRA for many years and won’t realize they need to consult with their attorneys.”