Employee Benefits for Small Employers: Your Questions Answered
By: Marilyn A. Monahan is the owner of Monahan Law Office in Marina del Rey.
Small businesses often have questions about the types of health and welfare benefits they can offer to their employees (or to themselves). Guidance on these issues is not readily available, and the answers are sometimes (unfortunately) complicated. This article will answer some common questions small businesses have about benefit options, and flag some regulatory issues they should know about.
Where can I purchase health coverage?
Both individual and small group health plans are available from Covered California,[i] the state marketplace (or exchange) created pursuant to the Affordable Care Act (ACA). Individual and small group plans are also available outside the marketplace. In either case, a licensed accident and health agent may help with the selection and purchase.
Individual and small group health plans fall into 4 metal tiers: platinum, gold, silver, and bronze. A platinum plan, for example, will offer more generous benefits (such as lower co-payments and deductible limits) than a gold plan. The plans are underwritten by insurance companies and HMOs.
Individuals are only allowed to purchase an individual plan during Covered California’s annual open enrollment period, which begins November 1 of each year.[ii] This limit also applies to individual coverage purchased off the marketplace. If a person misses the annual open enrollment period, mid-year enrollments are only allowed if a person has a “special enrollment” event.
Small employers may purchase a small employer plan at any time during the calendar year, either from Covered California or outside of it. However, if an employee does not sign up at the beginning of the policy/plan year, the employee will only be able to enroll mid-year if he or she has a “special enrollment” event. Small group plans offered through Covered California are referred to as SHOP plans.
Can an insurer/HMO turn down my application for small group or individual health coverage?
No. Both individual and small group coverage are “guarantee issue,” which means that an individual or small employer cannot be turned down, so long as the applicant satisfies the plan’s eligibility requirements. The eligibility requirements for small plans are important limitations and are often the reason small employers who want to provide coverage are unable to.
What are the eligibility requirements for small group health plans?
In California, employers with up to 100 “full-time equivalent” employees are eligible for small group health coverage.[iii] Very small firms should know that to be eligible for a small group plan the employer must have at least one W-2 employee other than a business partner or spouse.
As part of the eligibility requirements, the insurer/HMO will require the small employer to offer coverage to all eligible employees. An eligible employee is someone who works 30 or more hours per week.
In addition, the insurer/HMO will impose minimum employer contribution and participation requirements on the small employer. If the employer cannot satisfy these requirements, the insurer/HMO will not issue coverage.
What are the minimum employer contribution and participation requirements for small employer plans?
The insurer/HMO will require the employer to pay at least 50% of the cost of employee-only coverage (the employer is not required to contribute toward the cost of coverage for employees’ dependents).[iv] In addition, the insurer/HMO will mandate that at least 70% of eligible employees enroll, unless they are eligible for certain other coverage. This other coverage cannot be an individual policy, but it can be a spouse’s employer’s plan, Medicare, or Medi-Cal. However, if the employer pays 100% of the premium for all employees, or if the employer only employs 1 to 3 eligible employees, then all eligible employees must enroll.[v]
Is any relief available if a small employer cannot meet the minimum participation and contribution requirements for small employer plans?
Yes. Each year, small employers that cannot satisfy the minimum participation and contribution requirements may apply for coverage between November 15 and December 15.[vi]
May employees pay the cost of their group health coverage pre-tax?
Yes. Employers may allow employees to pay their portion of the premium for their group health coverage pre-tax. This pre-tax arrangement is known as a “cafeteria plan.” A cafeteria plan must be set up in compliance with 26 U.S.C. § 125 and governing regulations.[vii] If the plan is not administered according to these requirements, the tax benefits of the pre-tax arrangement are forfeited.[viii]
Among other requirements, the employer must have a written cafeteria plan document, require that employees elect how much they will pay pre-tax before the start of the plan/policy year, and only allow employees to change their elections mid-year under certain specified circumstances.
Cafeteria plan documents may be prepared by an employee benefits lawyer, or may be obtained for a minimal fee from a payroll company or third party administrator. Setting up a cafeteria plan usually involves minimal administration, and most employees appreciate the tax savings. Employers also benefit, because as employee taxable income goes down, the employer has less to pay in employment taxes.
To satisfy California law, employers should obtain a written authorization before deducting insurance premiums from an employee’s paycheck.[ix]
Does the Employee Retirement Income Security Act of 1974 (ERISA)[x] apply to health and welfare benefits offered by small employers?
Typically, and regardless of the size of the employer, if an employer offers group health and welfare benefits to its employees, those benefits are subject to ERISA.[xi]
How does an employer determine if the benefits it offers to employees are subject to ERISA?[xii] First, for a plan to be subject to ERISA, it must be “established or maintained” by an employer[xiii]; in very general terms, group plans are subject to ERISA and individual plans are not. Employers often do not realize that if they pay the premiums on an individual policy, or take certain other steps such as “endorse” the individual policy, the employer may convert that individual policy into a group plan subject to ERISA.[xiv]
Second, the benefit must qualify as a “health or welfare” benefit. To fall into this category, the plan must provide “medical, surgical, or hospital care or benefits, or benefits in the event of sickness, accident, disability, death or unemployment, or vacation benefits, apprenticeship or other training programs, or day care centers, scholarship funds, or prepaid legal services.”[xv] In practical terms, this means that the following group plans are subject to ERISA: medical, dental, vision, prescription drug, mental health coverage, life insurance, short- and long-term disability, health flexible spending accounts (health FSAs); and prepaid legal plans. Two examples of plans that are not subject to ERISA are: dependent care spending accounts (which are subject to 26 U.S.C. § 129) and workers’ compensation benefits.
If ERISA does apply to a small employer plan, what does that mean?
In general, it means that an employer must satisfy all the reporting and disclosure requirements contained in ERISA. The Department of Labor’s Reporting and Disclosure Guide for Employee Benefit Plans (Sept. 2014), available on the Department’s website, outlines an employer’s obligations. Many of the disclosure requirements will be satisfied by the written materials provided by the insurer or HMO, but not all; any documents or mandatory terms missing must be provided by the employer.
In addition, employers are generally considered fiduciaries of the ERISA plan.[xvi] This means, for example, that employers must handle employee premium contributions consistent with ERISA’s fiduciary requirements. An ERISA plan fiduciary also has a duty to act solely in the interest of the plan participants and beneficiaries and with the exclusive purpose of providing benefits to them. The Department has also posted a publication summarizing fiduciary obligations: Meeting Your Fiduciary Responsibilities (Feb. 2012).
Is a small employer group health plan subject to COBRA[xvii]?
Maybe.[xviii] COBRA applies to employers with 20 or more employees.[xix] An employee enrolled in a group health plan maintained by an employer subject to COBRA is entitled to continue his or her coverage after a “qualifying event” (such as a reduction in hours or termination of employment that results in a loss of coverage). COBRA continuation coverage lasts for up to 18 months[xx] (36 months for dependents in the case of certain qualifying events). The participant must pay for the coverage (102% of the total cost of coverage, not just the amount paid by active employees).[xxi] The employer, not the insurer/HMO, is obligated to provide required COBRA notices to participating employees.[xxii]
In California, group health plans covering employers with fewer than 20 employees are subject to Cal-COBRA.[xxiii] Like COBRA, employees enrolled in their employer’s health plan may continue coverage under that plan following a qualifying event, such as a termination of employment, for up to a total of 36 months. The participant must pay the cost of coverage (and the insurer/HMO may charge up to 110% of the actual premium cost). Unlike COBRA, Cal-COBRA is administered by the insurer/HMO, rather than the employer.
May a small employer pay for an employee’s individual health policy?
Until 2017, the answer to this was no. The IRS and the DOL prohibited these arrangements—which the IRS refers to as “employer payment plans.” However, the employer can increase an employee’s compensation (but then cannot require that the employee use the increase to purchase health insurance).[xxiv] This latter type of arrangement is much less attractive to both employees and employers because the compensation is taxable. It is also important to note that employees cannot pay the premiums on an individual policy pre-tax through the employer’s cafeteria plan.
In late 2016, Congress passed the 21st Century Cures Act.[xxv] This Act allows certain small employers to set up a “qualified small employer health reimbursement arrangement” (“QSEHRA”), which can be used to pay the premiums on individual plans. Only certain employers are eligible to set up a QSEHRA, and the plans are subject to a number of rules. Expert guidance should be obtained.
May a small employer pay an employee’s out-of-pocket medical expenses?
Yes, but the employer has to follow the rules. An employer can set up a QSEHRA for this purpose, but cannot then also offer group health coverage. An employer could set up a “health reimbursement arrangement” (“HRA”), but the IRS and DOL have placed significant limitations on the structure of these plans (and, if they are set up, are subject to various IRS and DOL rules).
A common practice is for an employer to establish a health flexible spending account (or “health FSA”) as part of the employer’s cafeteria plan.[xxvi] With a health FSA, both the employer and the employee may contribute a certain amount of money per year on a pre-tax basis. This money is used to reimburse qualifying medical expenses that are not covered by the employer’s health plan (such as reimbursing co-pays and expenses subject to the plan’s deductible). In general, amounts contributed must be used during the plan year or they are forfeited. In 2017, employees could, by IRS rule, contribute up to $2,600 per year to a health FSA. While health FSAs are sometimes administered by the employer, many third party administrators also provide this service, including the required plan documentation. A health FSA is considered a health plan subject to ERISA as well as certain non-discrimination rules in 26 U.S.C. § 105(h) and § 125.
If employees are enrolled in a high deductible health plan (HDHP), participating in a health FSA may make those employees ineligible to contribute to a health savings account (HSA), unless the health FSA is a “limited purpose” health FSA that is set up to avoid this outcome. Employers should take this into account when structuring their benefits.
May a small employer contribute different premium amounts for different employees?
Maybe. In some circumstances, an employer may contribute different amounts toward health coverage premiums for different groups of similarly situated employees. The differentials should be based on bona fide employment-related classifications. Problems usually arise when the employer wants to contribute more for executives than other employees. If employees pay their premiums pre-tax through a cafeteria plan (which most employers allow), such an arrangement could fail the non-discrimination testing rules for cafeteria plans, which prohibit eligibility and benefit structures which favor highly compensated individuals.[xxvii] Employers should either contribute the same amount for all employees, or seek guidance.
Some tax issues small employers might not know about:
HSA contributions: An individual enrolled in a qualifying “high deductible health plan” (HDHP), may be eligible to contribute to a “health savings account” (HSA).[xxviii] Those contributions are tax deductible for federal income tax purposes. However, HSA contributions are not tax deductible for California income tax purposes; the state legislature has not passed conforming legislation. Additionally, different (and complicated) nondiscrimination rules apply to HSA contributions depending on whether the employer allows employees to contribute pre-tax through payroll reduction.
- Voluntary benefits: In addition to group health coverage, many employers offer employees the opportunity to enroll in “voluntary” benefit plans. Many employees appreciate this opportunity. However, employers should be aware that if an employee pays the premiums on voluntary benefits pre-tax through the employer’s cafeteria plan, or if the employer pays the premium, the value of the benefit should be included in the employee’s gross income. [xxix] In such an event, these benefits are much less attractive to employees. Therefore, employees should pay the full premium for voluntary plans, although employers can ease the administrative burden on employees by paying via a payroll deduction.
With all these factors in mind, is there an advantage to offering health and welfare benefits to employees?
Yes! Employees value a strong employee benefits package. Offering a robust benefits package helps ensure that an employer can both attract and retain the most qualified employees. In addition, employees who have health coverage are less likely to come to work sick (“presenteeism”), and are more likely to get better faster. There is also some indication that employers that offer health coverage have fewer workers’ compensation claims. Employers that establish cafeteria plans will also find that as employee gross income is adjusted downward, the employer’s employment tax obligation eases.
Marilyn A. Monahan is the owner of Monahan Law Office in Marina del Rey. She focuses her practice on insurance law and employee benefits—concentrating on health and welfare plans—including compliance under the ACA, ERISA, HIPAA, and COBRA. She is a past chair of the Solo and Small Firm Section.
This Article was reprinted with permission from the California Lawyers Association
[i] www.coveredca.com[ii] Open enrollment periods are subject to change by either CMS or Covered California. [iii] Cal. Health & Safety Code § 1357.500(k)(3); Cal. Ins. Code § 10965.3(q)(3) [iv] Cal. Code Regs. tit. 10, § 6522(a)(5). [v] Cal. Code Regs. tit. 10, § 6522(a)(4). [vi] Cal. Code Regs. tit. 10, § 6526(b). [vii] See Employee Benefits—Cafeteria Plans, 72 Fed. Reg. 43937 (proposed Aug. 6, 2007) (Proposed Regs.). [viii] Proposed Regs. at § 1.125-1(c)(7). [ix] Cal. Lab. Code § 224. [x] 29 U.S.C. § 1001, et seq. [xi] 29 U.S.C. §§ 1002(a), 1003. Plans established or maintained by government employers or churches are not subject to ERISA. [xii] ERISA also applies to retirement and pension benefits. [xiii] 29 U.S.C. §§ 1002(a), 1003. [xiv] 29 C.F.R. § 2510.3-1(j). [xv] 29 U.S.C. § 1002(a). [xvi] Under ERISA, the obligations technically fall on the “plan administrator” but, as that term is defined, the “plan administrator is usually the employer. [xvii] 26 U.S.C. § 4980B. [xviii] 26 U.S.C. § 4980B(d). [xix] 26 C.F.R. § 54.4980B-2, Q&A 5. [xx] The 18 month period may be extended to 36 months pursuant to Cal-COBRA (see Cal. Ins. Code § 10128.59(a)). [xxi] COBRA and Cal-COBRA premium may be higher for disabled participants. [xxii] See Reporting and Disclosure Guide for Employee Benefit Plans, Dept. of Labor (Sept. 2014). [xxiii] Cal. Ins. Code § 10128.50-.59; Cal. Health & Safety Code § 1366.20-29. [xxiv] IRS Notice 2013-54; https://www.irs.gov/affordable-care-act/employer-health-care-arrangements[xxv] Pub. L. No. 114-255 (2016). [xxvi] 29 U.S.C. § 125. [xxvii] Proposed Regs. at § 1.125–7. [xxviii] 26 U.S.C. § 223. [xxix] IRS Chief Counsel Memorandum 201703013 (Dec. 12, 2016).