Which situations? Well, when some deduction you report on your individual tax return deduction in effect connects to a trade or business.

For the most part, this requirement makes sense. But in one case, the IRS got crazy. Specifically, the IRS says S corporation shareholders subtract self-employed health insurance premiums twice in order to determine qualified business income.

This particular adjustment makes no sense to the typical small business owner. Some folks even talk privately about ignoring the instruction.

Accordingly, in this blog post, I dig into the details of this goofy instruction for S corporation shareholders. And then I talk about the argument for ignorance.

But let’s start with the bookkeeping the IRS wants.

A Quick Example of the Nonsense

Say an S corporation earns $100,000 before paying any shareholder wages. Further, say after careful consideration and a bit of research, the S corporation decides to pay its shareholder-employee wages equal to $60,000.

In this case, that leftover $40,000 counts as Section 199A qualified business income. The shareholder-employee probably gets an $8,000 Section 199A.

Note: The Section 199A deduction typically equals 20 percent of the amount shown on the S corporation’s K-1.

But you may need to adjust the qualified business income, as noted. And here’s the rub with an S corporation.

If the S corporation buys health insurance for the shareholder-employee, the IRS says (in Notice 2008-1) that the health insurance gets added to the wages.

If this same corporation pays $20,000 in health insurance for the shareholder-employee, the IRS’s bookkeeping pushes up the wages from $60,000 to $80,000. And it pushes down the qualified business income from $40,000 to $20,000.

And then the other shoe drops.

The 8995 form instructions say the shareholder-employee also needs to subtract the $20,000 of health insurance. Again.

In a case like the one described here? That second reduction shrinks the qualified business income from $20,000 to $0. That shrinkage zeroes out the Section 199A deduction.

Note: As discussed in another blog post,  How the IRS Destroyed the Section 199A Deduction for Small Business Corporations and Partnerships, this same bookkeeping nonsense reduces qualified business income and the Section 199A deduction for partners in partnerships, too.

What Our CPA Firm Will Do

Just for the record, our firm will follow the 8995 instructions.

Partly, this policy stems from the modest impact of the nonsense prescribed by the IRS.

I used $20,000 in the example just described as the total health insurance amount.

But with a more typical $10,000 self-employed health insurance deduction, for example, the IRS bookkeeping method costs taxpayers $400 to $700 of lost tax savings.

That amount crosses the “okay this is irritating” threshold.

But not the “I don’t care about getting into an argument with the IRS” threshold.

However, I think some business owners and tax accountants probably will ignore the IRS’s 8995 instructions. And in my opinion, their position isn’t frivolous.

But to understand why, it helps to look first at when the IRS approach makes total sense.

Why the IRS Wants this Bookkeeping Approach

As noted earlier, the 199A regulations require adjustments to the qualified business income number that flows out of a business (like a sole proprietorship) when some deduction you report on your individual tax return deduction effectively connects to a trade or business

The final regulations detail the actual rules for determining when some item is effectively connected. And those rules say this:

Thus, for purposes of section 199A, deductions such as the deductible portion of the tax on self-employment income under section 164(f), the self-employed health insurance deduction under section 162(l), and the deduction for contributions to qualified retirement plans under section 404 are considered attributable to a trade or business to the extent that the individual’s gross income from the trade or business is taken into account in calculating the allowable deduction, on a proportionate basis.

By the way, you may want to read the paragraph twice. Once in its entirety. Once reading just the boldfaced language.

But the gist of this?  To get a business’s qualified business income, we adjust the business’s income for “business-y” expenses that don’t appear on the actual business tax return.

A sole proprietor, for example, pays self-employment taxes if her or his business makes a profit. She or he gets to deduct a pension contribution, such as for something like a simplified employee pension plan (a SEP-IRA) if her or his business makes a profit. And she or he gets a self-employed health insurance deduction if the business makes a profit.

Logically, these expenses are “effectively connected” to the business. And so the taxpayer should tweak their qualified business income for these deductions.

A relevant sidebar? These sorts of expenses, in comparison, do appear on a corporation’s tax return.

But it’s hard to see why this bookkeeping makes sense for S corporations. And for two reasons which form the basis for ignoring the IRS 8995 instructions.

The First Reason You Might Argue the 8995 Instructions Don’t Apply to S Corporations

A first, common-sense reason to ignore.

The bookkeeping approach the IRS requires for self-employed health insurance in S corporation situations already indirectly reduces the qualified business income.

How? As already explained, the IRS requires self-employed health insurance to be counted as W-2 wages. W-2 wages reduce an S corporation’s qualified business income. That reduction means S corporation qualified business income is already and automatically adjusted for the self-employed health insurance.

That sounds pretty good, right? Yeah, I agree.

Unfortunately, while this reason maybe makes perfect sense to you and me, it makes no sense to the IRS’s tax attorneys. Apparently.

Note: The above reasoning might, I will guess, resonant with an IRS auditor, her or his manager or an IRS Appeals officer. But that’s not really relevant…

The Second Reason You Might Argue the IRS Instructions Don’t Apply to S corporations

But a second reason also maybe lets S corporations ignore the IRS 8995 instructions about self-employed health insurance.

Remember from the earlier paragraphs that the regulations require adjustments to qualified business income when a deduction is effectively connected to a trade or business. And the “effective” connection per the regulations occurs when

for purposes of section 199A, deductions such as the self-employed health insurance deduction under section 162(l) are considered attributable to a trade or business to the extent that the individual’s gross income from the trade or business is taken into account in calculating the allowable deduction

You probably see I’m just copying the boldfaced language from the regulations I showed earlier.

Now clearly, the above language applies for sole proprietors and partnerships.

But look at the rule for the self-employed health insurance deduction for S corporations which I copied from IRS Notice 2008-1. For an S corporation shareholder-employee, the rule says

The deduction is not allowed to the extent that the amount of the deduction exceeds the earned income (within the meaning of section 401(c)(2)) derived by the taxpayer from the trade or business….

Slightly restated, for S corporations, the self-employed health insurance deduction doesn’t look at the extent that an individual’s gross income from the trade or business is taken into account.

Rather, the deduction limits the deduction to the taxpayer’s earned income from the business. (Most specifically, what shows up in Box 5 of the shareholder-employee’s W-2 as “Wages subject to Medicare taxes.”)

Mash up the instructions from IRS Notice 2008-1 with the regulations’ language—all the while paying attention to the adjectives “gross” and “earned,” and voila, the language seems to say sole proprietorships and partnerships adjust. But that S corporations don’t.

Connecting the Dots

So, to wrap this up? If you’re going to argue the IRS instructions make no sense, you essentially make two arguments.

First, you argue the S corporation already has subtracted health insurance from the qualified business income by using the bookkeeping method prescribed in IRS Notice 2008-1.

Second, you argue the only detailed guidance says you adjust for self-employed health insurance in situations like those a sole proprietorship or partnership faces where the deduction depends on the gross income of the business.

And my final remark about all this? I understand the arguments for ignoring the IRS 8995 instructions.  I really do.

But in our practice? For a few hundred dollars of lost savings? Yeah, we’re just going to follow the IRS form instructions.

The post Ignoring IRS 8995 Instructions to Double-deduct Self-employed Health Insurance appeared first on Evergreen Small Business.

Presumably, President Obama will sign the legislation today or later this week.

And once that happens, small businesses will once again have an easy option (sort of) for providing health insurance for their employees.

Why Healthcare Reimbursement Arrangement Matters

Talking about the Affordable Care Act, better known as Obamacare, risks turning into a political argument. But putting politics aside (at least for the next twenty or so minutes), we think this new health insurance arrangement is a big deal for small businesses. And a real opportunity.

Here’s why: Obamacare created an expectation that employers will provide health insurance for employees. But at the same time, Obamacare unintentionally blew up the common, shortcut approach that small employers used for decades to provide insurance to their employees… which was to pay employees an amount (tax-free) that let them buy their own individual health insurance.

As discussed here, you could operate such a plan but the penalties were catastrophic.

How Qualified Small Employer Health Reimbursement Arrangement Works

The new law (text available here) sort of puts humpty-dumpty back together.

Specifically, starting in 2017, you can set up a plan, or an arrangement, where you reimburse for your employees’ individual health insurance as long as you carefully follow some rules that honor the spirit of Obamacare.

For example, the plan needs to be provided on the same terms to all “eligible employees” and you have to notify your employees that the plan exists.

Tip: You’ll want to really understand the employee non-discrimination rules before you set up your own health reimbursement arrangement. We’ve talked about these rules a bit in the past on our blog here (scroll down to old rule #2).

In addition, your business needs to be an “eligible employer.” This means the employer isn’t an “applicable large employer”, which is generally a business with 50 or more employees. (If your business is comfortably below 50 employees,  you can have a qualified small employer health reimbursement arrangement. If you’re near the cutoff, however, ask a tax professional to help you sort through the rules.)

No salary reduction contributions are allowed; only the employer can contribute. Further, the plan can only reimburse employees for medical expenses as defined under IRC § 213(d). Medical expenses under this definition include health insurance, but also include out-of-pocket medical expenses. But the employee needs to prove to the employer that they have health insurance coverage before the employer can make any reimbursements.

In general, the employer cannot pay out more than $4,950 a year for an employee unless the plan also covers the employee’s family, in which case the employer cannot pay out more than $10,000 a year. Also, these amounts get prorated; for example, if an employee is only on the plan for 5 months of the year and they don’t have extra relatives to cover, then the annual limit is 5⁄12 × $4,950 = $2,062.50.

Finally, an employee needs to have minimum essential coverage in order for the reimbursements to be excludable from the employee’s income. (More on this in a minute.)

Qualified Small Employer Health Reimbursement Arrangement Effective Date

I said this earlier in passing, but just so it’s clear: An employer can offer a qualified small employer health reimbursement arrangement only for years starting after December 31, 2016.

A reimbursement arrangement doesn’t work retroactively for 2016, therefore.

And a related point: Because the new option is more complicated than simply writing a check, we think you need to move fast in order to have a plan in effect at the start of the new year.

Two Other Really Important Rules to Know

As we all learn more about the new law, we’ll uncover new details and surely get additional guidance. But two other important points to know from the very start.

A first really important rule I already mentioned: The insurance paid for through one of these arrangements needs to meet the Affordable Care Act’s “minimum essential coverage” threshold. “Minimum essential coverage” is defined in IRC § 5000A(f). It is the minimum amount of coverage that your employees will need to not be subject to the penalty for not having health insurance.

If your employee receives a reimbursement and they don’t have minimum essential coverage, you include the reimbursement amounts on their W-2. Practically speaking, this extra complication means that you’ll want to establish some way of verifying that your employees have individual health insurance throughout the whole year in order to avoid creating a payroll accounting mess for yourself.

And a second really important rule: You need to provide employees with a statement that both notifies them of their eligibility to participate in your plan and describes all of the information that their state’s exchange might need to calculate their eligibility for a premium tax credit. And just so you know, this premium tax credit comes into play if an employee needs to kick in more than 9.5% of their income to pay for the part of the health insurance premium that you (the employer) are not paying.

Need More Help with the Small Businesses and the Affordable Care Act?

If you’re a tax practitioner advising small business clients about how to navigate the treacherous waters of healthcare reform, you may be interested in our monograph, Small Businesses and the Affordable Care Act, which is available for $100 and which includes sample forms, client letters and handouts you can use for explaining the mechanics of the Affordable Care Act to your clients.

We think this short whitepaper (roughly 70 pages in length) should save tax practitioners several hours of learning time. For example, it describes the ACA issues that you need to understand for your small business clients in detail and is richly footnoted with hyperlinks to primary source authorities. The monograph also provides a boilerplate healthcare policy document practitioners can use for their clients, and it supplies example W-2 forms to show how these items should be prepared given the ACA. We’ve also included sample client letters and longer “handouts” you can use to communicate with clients.

The whitepaper includes coverage of the “Qualified Small Employer Health Reimbursement Arrangement” option created in December 2016 by the 21st Century Cures Act.

If you’re ready to buy you can use this button below. Or if you need more information, click here.

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As with all of our publications, the Small Businesses and the Affordable Care Act (Obamacare) monograph comes with a money-back guarantee, so if you purchase it and then for whatever reason find it’s not what you need or what you expected, simply email us your refund request. We will happily issue you a refund, no questions and no hassles.

The post Qualified Small Employer Health Reimbursement Arrangement Rules appeared first on Evergreen Small Business.

No, I get it. The economy has been tough in many parts of the country. In some cases, for years now.

Further, overall inflation seems low. Look at oil prices or interest rates, for example.

But I still think you need to get much, much more disciplined about regularly bumping up your prices by some percentage for inflation. And just to get this admission out, so should I.

Let me in this post, therefore, outline the math behind this suggestion and then share three comments that may help you think more concretely about and also feel more comfortable with this idea.

Reviewing the Math of Inflation

Let’s start by quickly outlining how the math of inflation works if you don’t adjust your prices regularly for changes in price levels.

Assume for purposes of illustration that you run a business with $200,000 in revenue. Further, assume half of that revenue, or $100,000, goes to pay the expenses of running your business. The remaining half represents your profits.

The table below shows what happens if over three years inflation runs 2% (so hardly enough to worry about) but you don’t bump your prices by 2% annually.

I rounded the numbers shown in the table to the nearest thousands—which makes the table easier to read but sort of understates the problem. But you see what’s going on, right? Every year that you don’t in this hypothetical situation adjust your prices for inflation, you lose a little bit of profit.

No year’s reduction in profits kills your business, obviously. But the profits are slowly deflating.

And now let me make three points.

This Situation is Critical

Here’s a first thing to consider. While the slow reduction in profits in the given hypothetical situation seems minor, in truth, the situation is critical.

Profits of $94,000 doesn’t seem that much less than the $100,000 in profits enjoyed only three years ago. If you or I actually confronted this exact situation, we can surely figure out ways to continue operating, right?  (Maybe we just work a little harder ourselves.)

Further, even if we do take home a few thousand less in income, we can surely deal with such a shortfall by cutting expenses at home. (Maybe we can temporarily stop saving money for retirement.)

But really a hypothetical pattern like the one described here is terrible. And let me point out two factors to support this statement.

A first factor… We can’t fairly compare that $94,000 of year 4 profit to the $100,000 of year 1 profits. With 2% inflation over the last three years, we need to compare the $94,000 of year 4 profits to the $106,000 you or I should be making in year 4 in order to “keep even” with increasing prices. (If we would have bumped our profits by that 2% a year—like the operating costs bumped up by 2% a year—that $106,000 is what we would be earning in year 4.) In year 4 dollars, in other words, the business is actually be “down” by about $12,000. That’s a lot.

A second awkward factor to this slow-motion disaster: The situation keeps getting worse as long as you or I procrastinate about adjusting our prices for inflation. Ugh.

But Aren’t Prices Flat?

Let me share another comment about those inflating operating expenses. You might look at those and say, “Well, sure Steve, I get the math. But my prices aren’t really inflating. Or at least not by much. Seriously, interest rates are low. Oil is cheap. There basically isn’t any inflation if you look at the consumer price index…”

Okay, so I sort of agree with you… except that you (and I) need to be careful about assuming that overall price inflation accurately measures the inflation we’re experiencing in our small business’s operating costs.

Our business expenses may be flat or increasing at a barely noticeable rate. Or, and maybe especially for small service businesses, lots of our business expenses may actually be increasing at rates rather in excess of what the consumer price index shows.

Note: You can get producer price index information by industry code from the Bureau of Labor Statistics (click here for that information). Note that you’ll need to fiddle a bit to turn the index values at various points in your industry’s history into annual inflation rates.

Further,  the inflation you’re experiencing in your personal living expenses plays into how you adjust prices for inflation, too, since your business profits need to stretch to cover the costs of taking care of your family.

My small business’s costs for labor, insurance, and taxes, for example, are all increasing at a rate rather more than the consumer price index. I bet the same is true for your small business.

You have a Good Explanation

One final comment about all this. But a reminder first: This isn’t a political blog, it’s a how-to blog. So I’m going to mention a couple of political topics but I’m only talking about them because they connect to inflation-triggered price adjustments. And with that point made, let me share a couple of things.

First of all, as a country, we are engaged in important discussions about bumping up minimum wage levels. Some localities, including the Seattle area where we work, have already done this. Other areas are talking about it. And all of the major candidates for president in the next election say that we as a country need to do this. Keep that thought in your head for a minute.

Now on to something else. The law of the land says that all but the smallest businesses need to provide health insurance to their employees. And that’s a cost bump for many small businesses. Further, for any businesses that do provide it, healthcare costs and therefore health insurance costs continue to increase in price by a rate greatly in excess of the overall consumer price index.

I don’t mention these two factors to start a political argument. Let’s do that someplace else. But it seems like we can all agree, no matter what our political feelings, that these factors drive up the labor expenses and therefore the operating costs of small businesses.

Further, it seems like the roughly half of your customer-base who support politically the candidates who’ve brought these issues forward have to accept you bumping your prices to cover the cost increases.

And, just to be practical, even the roughly half of your customer-base who don’t politically support something like a big bump in minimum wages or a requirement for businesses to provide health insurance get that you and I need to follow the rules, that following those rules pushes our costs up, and that we need to pass along those cost increases to customers in the form of price increases.

Summing up the situation, if society instructs small businesses to bump up their operating costs, I think small businesses can take that instruction as a license to raise prices to cover the cost increases.

My final comment then? Go ahead—do it. Bump your prices by some amount that reflects a “cost of living adjustment.” And then continue to make the bump each year from this point forward. I think the facts and circumstances totally justify this practice for most small businesses. Really, I do.

The post Please Bump Your Prices for Inflation appeared first on Evergreen Small Business.

To start, though, let’s clarify: we’re not talking about the individual exchange. Washington State’s individual exchange really works quite well, despite what many may think given the initial disaster that was Healthcare.gov.

We’re talking about the small business side of the Exchange, where things have not been going so well. And several reasons justify nervousness…

Reason #1: Difficulty Getting Insurers to Bite

A first reason? Too few insurers are participating.

In 2017, for example, most counties in Washington State won’t even be served by the small business side of the Exchange.

This is because UnitedHealthcare is exiting the Exchange, and up until now UnitedHealthcare was the only small business insurer the Exchange had for most counties (Clark and Cowlitz being the exception).

I’ve asked representatives of the Exchange what they attribute this to, and have really only gotten non-answers back like “well we’re having conversations with carriers…”

Poking around at Exchange meeting materials that are available publicly on its site, it sounds like what might be going on is that there are some major changes to the IT infrastructure of the site before a lot of insurers are willing to give this thing a try (maybe because the site needs to be better to lure more customers?)

Yes, I acknowledge that “sounds like what might be happening” is about as speculative as it gets, but until the Exchange leaders become a bit more forthcoming about what’s going on, we don’t really have much to go on.

However, if we’ve deduced correctly that this is the problem, then this is a bigger problem for Washington State small businesses for reasons #2, 3, and 4, which I’ll describe next.

Reason #2: Lack of Capital Reserves for Big Projects

Another reason to be nervous? A lack of adequate capital reserves—and a lack of a plan to acquire and maintain adequate capital reserves.

In a recent state auditor’s report, for example, one of the key recommendations for putting the Exchange on a path to sustainability was for the Exchange to establish a long-term financial plan, a working reserve, and a capital reserve.

We should note, for the sake of fairness, that the Exchange is working on this. The Exchange indicated in its response to the state auditor’s report that it has commenced work on establishing a long-term financial plan that includes developing a reserve, and is due to complete this work by December 31^st, 2016. However, any efforts the Exchange makes to implement effective long-term financial planning are hampered by policies of the Legislature described in #3 and 4, below.

Reason #3: Legislature’s Spending Rules Stop the Exchange from Swiftly Investing in Needed IT Improvements

A third issue: the lack of support from the Legislature for continuous basic improvement in the information technology required to run a decent exchange. Which sounds crazy.

It is in the Legislature’s best interest to enable the Exchange to make certain improvements to its website as soon as it can, because many of these improvements accelerate the Exchange’s path toward self-sustainability. This is for two main reasons:

• Because it improves the customer experience, making it easier for the Exchange to find more customers and thus reducing the Exchange’s per member per month costs, and
• Because improvements such as fewer software bugs, better user interfaces, and additional features that allow customers to perform tasks themselves on the website reduce the need for spending on customer support.

However, in HB 1947 (2013) the Legislature tied the Exchange’s hands when it comes to implementing cost-saving IT improvements. Specifically, the bill states that the Exchange can only spend as much money as the Legislature appropriates to it. In addition, the bill includes a “sweeping provision” which states that the Legislature may transfer money from the Exchange’s account to the general account.

To illustrate: for the current biennium (2015-2017), the state budget does not, in fact, simply state that the Legislature will contribute $110 million to the Exchange. Instead, what it states is that the Exchange may not spend more than $110 million. Therefore, even if the Exchange were to successfully apply for a grant elsewhere, that grant would have zero impact on the Exchange’s ability to accelerate investments in IT improvements in the current biennium. Instead, the money would likely be swept into the state’s general fund.

This policy was ostensibly intended as a measure to hold the Exchange more “fiscally responsible.” However, in practice it creates a perverse incentive for the Exchange board to not seek out grant funding as a way to accelerate cost-effective IT improvements. This is because seeking out grants would require considerable effort while providing the exchange with no financial benefit. (I’ve even had representatives of the Exchange tell me that this is their thought process behind why they don’t bother pursuing grants.)

Reason #4: Legislature’s Sweeping Provision Makes Exchange Finances Unstable

And then there’s the “sweeping” issue, which maybe makes sense for a typical government program but not for an organization with the cash flow uncertainty of the Exchange.

What’s the issue here? Simple. The provision in HB 1947 authorizing “excess funds” to be removed from the Exchange’s account and placed in the Legislature’s general fund appears to complicate the goal of developing stable reserves. In fact, the auditor’s report specifically asked the Legislature to consider as part of the appropriation process “the Exchange’s long-term financial plan, its planned list of IT investments, its need for both working and capital reserves, and how sweeping those reserves adversely affects planning.” [emphasis added]

It’s worth emphasizing here that a big part of why this is so important for the Exchange is that both the amount and the timing of the Exchange’s cash inflows are uncertain. The amount is uncertain because much of the Exchange’s revenue comes from a 2% health insurance premium tax and assessments that the Exchange can charge insurers who sell plans through the website (almost a bit like a commission, to cover the Exchange’s operating costs).

Timing is uncertain because a large additional portion of the Exchange’s revenue comes from reimbursements from Medicaid for costs the Exchange incurs on Medicaid’s behalf. And, as awkward as this is to point out, according to the state auditor’s report Medicaid has a history of not paying its bills to the Exchange on time.

This is the whole reason the Exchange needs a working reserve (and why, as small business owners, we need to be thinking about liquidity, too). If projected revenues come in a little lower than expected, the Exchange needs some cushion so it knows it can keep the lights on and the servers running. Ditto for if Medicaid pays a bill a few months late. So how nerve-wrecking is it that the Exchange could do the responsible thing by building up an adequate working reserve, only to see the Legislature sweep it all away because some state legislators think that reserve is “excess funds”?

Final Thoughts

These things are all fixable. And to the extent that the Exchange’s leaders have the power to, they seem to be putting a lot of work into trying to fix it.

However, the Legislature still has some things it needs to do if it really wants to get this program working. It needs to change the Exchange’s enacting legislation to remove counterproductive policies such as the appropriations rules and the sweeping provision, and replace these with constructive policies.

Examples of constructive policies the Legislature could enact include:

• Requiring the Exchange to have a long-term financial plan that includes provisions for a working reserve and a capital reserve.
• Requiring the Exchange to prepare a report for the Legislature explaining why they’ve had such trouble inducing insurers to participate in the small business side of the Exchange, and what their plan is to fix it.
• Requiring the Exchange to conduct ongoing user interface studies, including studies of how efficient and intuitive it is for the typical user to work with both the individual and SHOP portions of the website.
• Requiring the Exchange to conduct ongoing surveys among Washington residents and small business owners on features they would like to see included as part of both the individual and SHOP portions of the website.

We’re keeping up to date on developments with the Washington SHOP Exchange, and will post updates to this blog as they become available. Stay tuned.

The post Why You Should Be Nervous About Washington’s SHOP Exchange appeared first on Evergreen Small Business.

If you’re interested in the blog post that Bob referred to, click here. (The other blog post, by the way, provides the nitty gritty details the post you’re reading right now lacks.) But here’s what you really need to know and act on quickly…

Step 1: Cancel Any Employer Payment Plan

You need to cancel any employer payment plan (EPP) where you give money to employees which they then use to buy individual health insurance. Yes, for decades small businesses used this approach. And it worked pretty well. But you can’t do this anymore. Sorry.

We’ll talk about the penalties you risk if you continue this practice in a minute…

But let us say this: We think you need to be careful of anything that smells like an employer payment plan. For example, if you used to pay $250 a month for Tom’s insurance, $300 a month for Harriet’s insurance and then $150 a month for Dick’s insurance, we think it’s risky to stop doing that and then simultaneously add $250 a month to Tom’s check, $300 a month to Harriet’s check, and $150 a month to Dick’s check unless you’re really careful and follow some essential rules to show that you truly have “completely abandoned” the old EPP:

• Don’t recommend they use the extra money to buy health insurance, tell them to do whatever they want with it.
• Don’t recommend any particular health insurance plan to purchase.
• Don’t give the extra part of the paycheck any special tax treatment when you enter it in your payroll software.

Note: For 2017 and later years, you can use a qualified small employer reimbursement arrangement. (Click that link for details.)

Step 2: Cancel Any Healthcare Reimbursement Arrangements

You also need to cancel any healthcare reimbursement arrangements (sometimes also known as Sec. 105(b) plans) unless you’ve paired the HRA with a true small-group health plan. In the past, you could sometimes also get these arrangements to work as a way to provide for health insurance premiums and more commonly pay for uncovered out-of-pocket and copay expenditures. But you also shouldn’t do one of these any more except in limited circumstances (ask your tax adviser).

By the way, a word about the penalties of not taking steps 1 and 2: The risks of you using an employer payment plan or a healthcare reimbursement arrangement are shockingly high. You could be fined a $100 a day per employee. So, just to do the math, if you have five employees and get hit with the penalty, you’re looking at about $182,500 in penalties for a year of breaking the rules.

That’s 5 employees… each triggering a $100 penalty or $500 a day in total… for 365 days. Ouch.

Tip: A quick point: If you’ve been using something like a healthcare reimbursement arrangement to jack your small business’s tax deductions, you should know that there are probably other, lower risk ways to do this.

The plain fact is, federal and state tax laws provide small businesses with dozens of powerful tactics for cutting taxes.

If you want information about how to take advantage of these “loopholes,” consider our popular downloadable ebook “Small Businesses Tax Deduction Secrets“.

Step 3: Don’t Worry about S Corporation Shareholder-employees… Yet

If your business is an S corporation and you were correctly handling your shareholder-employee health insurance before—which means following the rules described in IRS Notice 2008-01—you don’t need to change anything.

The pre-Obamacare accounting still works the same way. But you need to be careful and alert because the IRS may change the accounting for your situation at some point in the future.

Note: A shareholder-employee’s health insurance is treated as wages and subject (potentially) to income taxes but not to payroll taxes like Medicare and Social Security. But usually, the health insurance becomes a “self-employed health insurance” deduction on the shareholder’s individual tax return.

Step 4: Plan on Your State’s Small Business Exchange Failing

An awkward point because it sounds political—but actually is not political.

Ever since the IRS and Department of Labor effectively banned EPPs, the clean way to provide health insurance to a small business’s employees has been to let employees use the state’s small business exchange. The mechanics of how you did this required a little bit of thinking. But in a sense, all an employer had to do was pick the level of “metal” like bronze or silver or gold or platinum that the employer wanted to pay for and then let employees sign up.

However, because of all sorts of reasons best left to other people to sort out, many SHOP exchanges don’t appear to be stable yet. In Washington State, for example, SHOP won’t be available in 2017 in most counties. For this reason, we think you ought to check now on whether your state’s SHOP exchange will operate after this year. And we think you ought to plan for the very real possibility that your state’s SHOP exchange might be unavailable in the future.

Step 5: Consider Going Bare

While Obamacare understandably sets an expectation that employers will provide for employee’s health care, we think your small business probably needs to consider going bare. Sorry.

For the record, this is the choice that, regrettably, we think our small CPA firm will have to select given that United Healthcare, the sole provider for our state’s SHOP exchange in most Washington counties, decided to withdraw from the state for reasons described here.

Yes, you can possibly set up a non-SHOP-exchange small group. But that choice seems impractical. Note that the whole reason the SHOP exchanges were created by Obamacare was that the SHOP exchange option was supposed to be the workable way for super-small employers to provide insurance without too much administrative burden.

Tip: If you are operating as an S corporation, you want to make any decisions about health insurance in light of how health insurance for shareholder-employees works and shareholder-employee salaries.

You can get more information about how to set shareholder-employee salaries, including the effect of health insurance on wages and pensions, in our “Setting Low Salaries for S Corporations” e-book.

Step 6: Consider Writing a Letter to Your Elected Representatives

A crazy idea? Can I suggest you consider writing a letter to your U.S. representative (click here to get that mailing address) and your state’s two U.S. senators (click here to get those address)?

There’s every tendency to write some long-winded complaint if you do this, of course. If I wasn’t trying to be on my best behavior here, who knows what I’d say. But as a practical matter, what I’m thinking is something a bit more “how to” in nature like this:

Dear Senator Murray, Senator Cantwell, and Rep. Del Bene,

While the continuing political discussion about the Affordable Care Act includes many points of view from all over the political spectrum, I write to ask you to work toward fixing an outcome which probably no one anticipated and surely no one involved wants.

As you may know, in Washington State as in many other states, the Small Business Health Options Program exchange (also known as the SHOP exchange) essentially fails at the end of this year because the only insurance company providing coverage in most counties is exiting the state. This means that small businesses like my own will no longer have a practical option to provide employees with health insurance.

Further, the Affordable Care Act prohibits small businesses from paying for employee health insurance through previously acceptable practices such as Employer Payment Plans as described in Revenue Ruling 61-146, and Healthcare Reimbursement Arrangements allowed an IRC Section 105(b).

I understand that action is tricky. But no matter what your political point of view, I respectfully ask you to consider the impact and hardship suffered by small business employers in your state when the Affordable Care Act sets up an expectation that employers provide health care, then prohibits long-used mechanisms for providing healthcare, and then fails to provide a functioning replacement option.

Sincerely,

Stephen L. Nelson, CPA

In addition, if you’re a small business owner in Washington State, definitely consider making a public comment to the Exchange’s board explaining what you need from them when it comes to employee health insurance. They want to hear from Washington small business owners so they understand what you guys need from them, and what you don’t.

Finally, if you’re a Washington State small business owner, consider writing to your legislator (you can find out who your state legislators are here) and explaining to them what’s happening to your small business as it relates to employee health insurance.

The post Really Simplified Guide to Small Business Obamacare Rules appeared first on Evergreen Small Business.

But you know what? With the Affordable Care Act now in full force, most businesses also need to spend time over the holiday season (and before year end) thinking about their employee health insurance programs.

Which explains (or at least sort of explains?) why we’re doing a blog post that connects the Breaking Bad television series and its principal character, Walter White, with the recent news that Healthcare.gov, the biggest Obamacare exchange, is going to offer fewer PPOs and more HMOs.

We want to explain why this maybe isn’t a bad thing, even if it seems like a bad thing…

An Extended Case for a PPO and Spoiler Alert

We briefly described the difference between HMOs, PPOs, and EPOs in our article on health insurance basics. But understanding this difference is really useful. Accordingly, I want to talk more about why PPOs seem attractive–and why they maybe don’t actually make as much sense economically.

And here’s how this all connects to Breaking Bad: The importance of the difference among these types of plans can be well illustrated with by the example of fictional TV character Walter White.

A misconception among people who didn’t pay careful attention to the series Breaking Bad was that Walter White was diagnosed with lung cancer when he didn’t have health insurance, and it was his lack of insurance coverage that meant (spoiler?) he had to start selling crystal meth to pay for his medical bills.

But Walt did have insurance. The issue was, in his own words, “I don’t have… great insurance.”

Why didn’t he have great insurance? Well, Walt had an HMO plan.

So he went to see a doctor in his network, who performed a series a tests. The doctor’s diagnosis was lung cancer. The prognosis? Best-case scenario: with chemo he lives a couple more years.

When Walt’s family finds out about his illness, they quickly determine that the network doctor isn’t good enough. Walt’s sister-in-law, Marie, knows who the best oncologist in town is, one Dr. Delcavoli.

Of course, the best oncologist in town isn’t in Walt’s network. Which is unfortunate. This top-tier doctor has a more optimistic opinion on Walt’s illness, but sadly that prognosis and the relevant treatment doesn’t come without a cost; the first visit alone is $5,000 out of pocket. His total out-of-pocket costs add up to $90,000.

This (among other reasons) is why Walt started making crystal meth. It wasn’t because he didn’t have health insurance. It was because once he and his family were staring death in the face, they decided that the HMO’s doctor wasn’t good enough. What they wished they’d had all along was a PPO that would have shouldered the cost of Dr. Delcavoli’s treatments.

The Case for Cutting Costs

Does a PPO provide you with better insurance? Well. that’s the big question. And Walter White answered in one way.

But here’s the rebuttal you’ll often hear from the pro-cost-cutting crowd: Most of this extra spending we do on health care in the U.S. isn’t buying us much.

In this interview with the PBS Newshour, for example, Harvard economist David Cutler explained a lot about why our country’s health care costs so much, and he did so in pretty good detail. There are many different reasons, but here he sums up the big idea we’re concerned with in our discussion:

[T]here’s a lot of gray area where it’s not clear if you need the open heart surgery or not, and in the U.S., people will get it and in Canada, they don’t. The interesting thing about it is that life expectancy or one-year mortality after a heart attack is the same in the two countries.

Cutler goes on in the article to discuss different things that Massachusetts has been trying to reduce “wasteful” health-care spending. This includes higher co-pays when patients go to more expensive health-care providers for routine procedures and higher out-of-pocket costs for patients who want procedures that aren’t clearly medically necessary.

You can see that this cost sharing makes cancer treatments for people such as Walter White more expensive. Experimental medicine? You’ll need to pay more for that. Choosing the most expensive doctor in town when it’s not clearly necessary? You’ll need to pay more for that.

This is the sort of thing that doesn’t make the Marie Schraders of the world very happy. But as Walt himself said when she suggested a supposedly better (though out-of-network) oncologist, his treatment would likely be “expensive, unpleasant, and ineffective.” And he was right.

And one final relevant comment. In the series, Walter lived several seasons. But the real reason Walt lived so long under Dr. Delcavoli’s treatment wasn’t because that’s how it usually happens in real life; it’s because Breaking Bad was a successful TV show that needed a decent number of episodes.

More Detailed Information Is Available

This past spring we published a monograph (downloadable as a PDF) for other CPA firms trying to help their clients deal with the Affordable Care Act’s complexity. If you’re a client of our CPA firm, we are happy to provide you with a complimentary copy of the monograph. Just call us.

If you aren’t a firm client but rather are a CPA, know that we’d be happy to sell you a copy of the monograph for $100. Roughly 60 pages in length, the monograph outlines everything you need to know to advise small-business clients on the elements of the Affordable Care Act they must know. The monograph also includes useful appendixes, which provide sample health plans, sample W-2s that show how an ACA-compliant W-2 should be prepared, sample client letters, and sample handouts you can use to help clients learn the new law. (Need more info? Click here.)

In summary, this relatively short whitepaper should save tax practitioners and their clients hours of learning time by describing the ACA issues that one needs to understand if one operates in the world of small business.

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Money-Back Guarantee

As with all of our publications, the “Small Businesses and the Affordable Care Act” (Obamacare) monograph comes with a money-back guarantee, so if you purchase it then for whatever reason find it’s not what you need or what you expected, simply email us your refund request. We will happily issue you a refund, no questions and no hassles.

The post Walter White Wished He’d Had a PPO appeared first on Evergreen Small Business.

Okay, so the New Year is right around the corner and that means, among other things, that now is the time to make health insurance decisions for the coming year. With that in mind, I thought I’d review the stuff you want to know about buying health insurance in Washington State.

First Thing to Know: You Can Probably Buy Health Insurance Yourself

Assuming that you’re an educated, rational consumer (which, apparently many people aren’t), you can buy health insurance yourself on Washington Healthplanfinder. If you’re uncomfortable doing this yourself then brokers and navigators are an option, but really, it’s not necessary. The computer skills required to sign up are similar to those required for making a purchase at Amazon.com (i.e., no real computer skills required whatsoever).

However, you want to be sure to do some research on the product itself before you buy. Accordingly, if you’re an individual purchasing health insurance for yourself or your family, this article will walk you through what you need to know. And if you’re a small business owner thinking about covering your employees, I’ve included links to some helpful resources on this stuff at the bottom of the page.

Understand the Product

You want to understand some basics about the health insurance product you’re shopping for and will ultimately purchase. Accordingly, let me define the basic vocabulary you need to know, explain the “metal levels,” and then outline the various plan options you will choose from.

The Basic Vocabulary

Here are the basic terms you need to know:

Premium – This is the bill you pay every month to remain covered under the insurance plan.

Out-of-pocket costs – This is the amount you have to pay out of pocket on medical expenses covered by your insurance plan, including copays, deductibles, and coinsurance.

• Copay – A flat fee you pay for medical services or products. This amount is generally charged when you receive the service.
• Deductible – The initial portion of your medical expenses not covered by a copay and not paid for by your insurance.
• Coinsurance – The portion of your costs that you pay once you’ve reached your deductible amount. For example, if a policy has 20% coinsurance and a $2,000 deductible, then once you’ve paid $2,000 of medical costs yourself you only have to pay 20% of your medical costs. In any given policy period (usually a year), you pay coinsurance up until the point your out-of-pocket costs have reached your out-of-pocket maximum.

Metal Levels

“Metal levels” are a new classification introduced by ACA. A particular plan’s metal level describes how much on average the health plan pays vs. what you the consumer pay out of pocket. Note that “on average” means that the amount you pay out of pocket might be a little more or less when all is said and done, depending on what medical expenses you incur during the year.

Predictably, lower metal levels have cheaper insurance premiums due to those higher out-of-pocket costs.

I should note also that there’s a fifth category, “catastrophic coverage.” This isn’t really a “metal,” but it’s a special category of coverage where the plan pays less than 60% of total average cost of care. Most people don’t qualify for catastrophic coverage; you’re only eligible for a catastrophic coverage plan if you’re under 30 or you qualify with a hardship exemption.

HMO, PPO, & EPO Plans

You should know the difference between HMO, PPO, & EPO plans. PPOs are more expensive than HMOs and EPOs, so before you buy you’ll want to understand what you’re paying for.

HMO stands for “health maintenance organization.” These plans make you pick a primary care physician, and then route all of your health care through that doctor. You only get to see another provider if either (a) your primary care physician refers you to one or (b) it’s a medical emergency. These plans tend to be cheaper, but the consumer loses a fair amount of flexibility and control in return for the cost savings.

PPO stands for “preferred provider organization.” These plans are more expensive than either HMOs or EPOs, but they give you the consumer more control and flexibility. You can go directly to a specialist if you like, and you can generally see health care professionals both inside and outside of your network (though staying in-network is generally cheaper because it reduces your copays and other out-of-pocket costs).

EPO stands for “exclusive provider organization.” These plans are a bit of a middle ground between HMOs and PPOs when it comes to cost vs. flexibility and consumer control. You can go directly to the specialist if you want, but you have to stay in network unless it’s a medical emergency.

You can see, then, how a consumer might choose between these different types of plans. If the idea of having to go through a primary care physician doesn’t bother you and you appreciate cost savings, then go with an HMO. If you dislike the idea of not getting to go directly to your preferred specialist whenever you want and you believe that flexibility is worth the extra cost, then go with a PPO. Or go with an EPO if you want something in between the two extremes.

How to Keep Your Doctor

If you already have a doctor you like, you’ll probably want to make sure that doctor is in your future health plan’s network. Washington Healthplanfinder makes it pretty easy to see which plans have your current doctor in their network. When shopping on the individual exchange, you’ll see in the upper left corner of the screen a section where you can enter your doctor’s information. Then just filter for plans that include your doctor in their network.

Understand Your Rights as a Consumer

The Affordable Care Act codified a variety of consumer rights, which you’ll want to know about as you’re looking at health insurance.

Here are some things your health insurance company can’t do, for example:

• Your insurance company can’t set an annual or lifetime limit for your coverage
• You generally can’t be discriminated against for having a preexisting condition
• You can’t be charged any out of pocket costs for medically necessary preventive health services (e.g. vaccines, routine screenings for common diseases)
• In 2015, you can’t be charged more than $6,600 in out of pocket costs if you’re on an individual plan or $13,200 if you’re on a family plan (amounts adjust each year for inflation).

In addition, your basic health insurance plan needs to cover 10 “essential health benefits.”

Understand Your Options for Financial Assistance

Consumers should know that the Affordable Care Act provides some significant financial assistance.

Premium Tax Credit

If your income is below a certain amount, you might qualify for a federal tax credit that offsets the cost of your health insurance premiums. You can apply for this subsidy as part of the process of purchasing health insurance through Washington Healthplanfinder. You can choose to either have the credit applied as a reduction to your monthly payments, or you can figure the credit all at once when you file your federal tax return.

Note: If your income ends up being higher than you forecast, you end up paying back some or all of the premium tax credit when you file your tax return.

Cost Sharing Reductions

If you purchase a silver plan through Washington Healthplanfinder, then you might qualify for cost sharing reductions based on your income. This will reduce your deductibles, copays, and coinsurance.

Washington Apple Health

If your income is below a certain amount, you might qualify for Washington Apple Health, our state’s Medicaid program. This health insurance is free. To see if you qualify, you apply through Washington Healthplanfinder (the same way you apply for a premium tax credit).

Understand the Tax Benefits of HSAs and HDHPs

Health savings accounts (HSAs) paired with high-deductible health plans (HDHPs) provide some very compelling tax benefits. And you’ll want to understand the potential benefits of an “HSA-pairable” plan before making a purchase on Washington Healthplanfinder.

Here’s the bottom line: HSA contributions reduce your adjusted gross income (AGI). This is true whether you make the contribution (the contribution is reported as an adjustment to income on your tax return) or your employer does (the contribution amount isn’t included in Box 1 of your W-2).

Several big tax benefits stem from this tax treatment.  The first, most obvious, benefit of this is that when you pay for out-of-pocket medical costs through an HSA, the money spent is pre-tax. So for example, if you earn $40,000 in a year and make $2,000 of HSA contributions, you pay income tax as if you made $38,000 that year. If your employer pays you with $38,000 of wages and $2,000 of HSA contributions, it’s a similar effect.

However, you should know that there are some other more subtle benefits of using an HSA. A second benefit is this: the premium tax credit described above is based on AGI. Therefore, if you’re a taxpayer whose income is in the range to qualify for the premium tax credit, an HSA contribution might not only lower your income tax bill, but also increase the federal subsidies you receive to pay for the plan premiums.

And now a third subtle benefit: You can pay for medical costs out of an HSA even if the plan it’s linked to doesn’t cover the costs. The only rule is that the expense has to be considered a medically necessary expense under federal tax law [specifically, IRC § 213(d)]. So for example, if you purchase a basic health plan that you pair with an HSA, but don’t purchase dental or vision coverage, you can still pay for dental and vision costs through your HSA and that money is pre-tax.

For Small Businesses: Make Sure You Understand the Law

If you own a small business, establishing a health insurance plan is a bit more complicated than it is for individuals to buy coverage.

The reason for this isn’t that it’s particularly difficult to use Washington Healthplanfinder’s SHOP exchange (though you’ll want to be aware of some “quirks” of the system before you try using it). Rather, it’s because before you purchase anything you’ll surely want to consult with quality professionals to make sure your plan is even legal.

For example, if your small business establishes a health plan for employees, then the plan needs to comply with the new market reforms in the ACA. Failure to follow the rules can result in a $100 penalty per employee per day. Yes, that’s $36,500 for each employee per year. It could destroy your business to mess this up.

These issues are too much to get into for one article, but you can see our e-book on these issues for more details, or contact us to schedule an appointment if you have more questions.

The post What to Know About Buying Health Insurance in WA appeared first on Evergreen Small Business.