I am getting more and more questions from employers who, for one reason or the other, would like to essentially provide each employee a health insurance "stipend" that could be used to pay for coverage under the employer's group plan or, alternatively, for premiums for other coverage if an employee elects not to participate in the employer's group health plan. In most cases, this seems to arise as a matter of "fairness" for the owners. The thinking is basically that they are willing to pay $X amount for group health insurance premiums for those employees participating in the employer's group plan so, therefore, they should be willing to pay the same amount to employees who forego coverage under the employer's plan when they have health insurance coverage elsewhere (e.g., spousal coverage, individual health insurance plans, etc.).

I have worked with employers who have established "opt-out" or "cash-out" programs under their cafeteria plans to make sure that those employees who actually elect coverage under their employer's plan are not subject to constructive receipt concerns by the IRS. One of the challenges of that approach, however, seems to be that the employees getting the stipend amount rather than coverage under the employer palnn must recognize the stipend in income and pay taxes on it while employees covered under the company's plan basically get the stipend on a pre-tax or "tax free" basis. The "fairness" rationale then leads the business owners to consider providing a tax "gross-up" or additional amounts to the non-electing employees in order to make up for the different tax treatment.

Also, as I understand it, having the employer contribute the stipend as an employer contribution or flex dollars to a health FSA for those employees not electing employer plan coverage poses big problems because the health FSA rules do not permit participants to use the account to pay for health insurance premiums.

All of this has me wondering if the better approach is not be to establish a simple medical reimbursement plan whereby the employer agrees to reimburse all eligible employees for amounts spent on health insurance premiums up to a maximum monthly stipend amount. For example, if an employee is willing to give each employee up to $300 per month to cover the cost of major health insurance premiums (whether under the employer's group health plan or through other coverage), as long as the employer requires proof that the amounts are essentially being paid in arrears to reimburse the employee for legitimate health insurance costs, shouldn't those payments be tax free?

Would this vary if the amounts being reimbursed were premiums paid by a spouse on a pre-tax basis under a cafeteria plan sponsored by a spouse's employer? Would this potentially be discriminatory if the reimbursement formula provided for payments of 50% of monthly health insurance premium costs up to a maximum of $300 per month? Perhaps that depends on which employees are getting the maximum reimbursement amounts and which are not.

Granted requiring a receipt / proof of premium payments would be a real pain but it seems to me it's preferrable to having the stipend treated as taxable income to those participants that do not elect coverage under the employer's plan. I don't see many folks with these sorts of reimbursement plans these days--at least not outside the very small company / nonprofit sector. Admittedly, I also don't see many employers who are willing to pay a stipend or otherwise make a contribution to the cost of health insurance coverage outside of the employer's own plan but the interest in such programs seems to be on the rise.

I would be grateful for any thoughts on the best or most tax-efficient way to make these sorts of programs work. Thanks.

401k Chaos,

I think your MERP idea generally looks like a good fit.

I don't have readily available the cite, but there's an IRS ruling that the insurance must be owned by the employer or the employee to be tax-free. It can't be owned in the name of a spouse, or a spouse's employer.

As for reimbursing the premium payments that your employees might make on their individually owned health policies, this is permitted in the tax-free context. See Rev Ruls 61-146, 75-241 and 2002-3. However, you will likely run into problems of compliance with group health plan rules, like HIPAA special enrollment rights, COBRA continuation coverage rights and Pregnancy Discrimination Act rights.

You could also do a cafeteria plan with all the benefits there, make the $300/mo/EE available at the employer's expense to be used by each employee for any of the non-taxable benefits, but not available as cash, and permit employees that want more than $300/mo worth of tax free benefits to agree to pay the difference through agreed-upon compensation reduction.

J Simmons,

Thanks very much for your thoughts. I think the prohibition on reimbursing premiums paid on coverage through a spouse's policy takes me back to just providing cash, unfortunately. In the particular case at hand, most of the employees with outside coverage have it through spousal coverage rather than simply on their own. The other issues you raise also seem to favor not adopting a MERP as a simple, low-maintenance alternative.

The employer in this case already pays the premiums on the remaining limited benefits items so, for better or worse, the $300 stipend would generally need to go to health insurance premiums to really accomplish it's goal. There just isn't anything else to cover on a pre-tax basis to offset that contribution.

Unless someone else has creative alternatives, I think all that means the employer will end up paying cash, subject to taxes, to those employees not participating in the group plan. Thanks.