On February 18, 2000 and on January 26, 2007, the Internal Revenue Service (IRS) issued Private Letter Rulings (PLR) 200007025 and 200704017 respectively. The issue before the IRS was whether the partnership’s self-insured medical plan was an arrangement having the effect of accident or health insurance.

As a general rule, partners are treated as self-employed rather than as employees for income tax purposes. In addition, under IRC Section 1372, S corporation shareholders who own more than 2% of the stock are treated the same as partners of a partnership for fringe benefit purposes.

In PLR 200704017, the IRS ruled that a self-employed individual may deduct premium payments to a self-funded health plan, and is not required to include reimbursements from the plan in gross income. According to the IRS, they reached this conclusion because the health plan had the characteristics of insurance. The major point made by the ruling was that the self-funded plan adequately shifted risk among plan participants. The ruling states that the risk shifting will occur when an insurer agrees to protect the insured against an economic loss in exchange for the payment of a premium by the insured. 

Based on the specific facts presented, the IRS ruled that partners can deduct premium payments to their partnership’s group health plan and exclude benefit payments from their gross income as long as the plan has the effect of accident or health insurance. 

Under IRC 104(a)(3) payments of medical expenses should be excludable from income as long as they are treated as received through accident or health insurance or an arrangement having the effect of accident or health insurance (and that is not merely a reimbursement arrangement). Under IRC 162(1) premium payments made by individual partners for coverage under the Plan will be deductible by them, subject to limitations of that provision. 

In PLR 200007025, the IRS also ruled that a self-employed individual may deduct premium payments to a self-funded health plan, and is not required to include reimbursements from the plan in gross income.

In PLR 200007025, the IRS noted that “the language “or through an arrangement having the effect of accident or health insurance)” in section 104(a)(3), was added to the Code by section 311 of the Health Insurance Portability and Accountability Act of 1996 (HIPAA), 1996-43 I.R.B. 7, effective for taxable years beginning after December 31, 1996.  HIPAA Section 311 also increased the amount of the deduction under section 162(I)(1)(A) of the Code. The legislative history of section 311 “Increase in Deduction for Health Insurance Costs of Self-Employed Individuals”, states that under present law, self-employed individuals are entitled to deduct 30 percent of the amount paid for health insurance for the self-employed individual and the individual’s spouse and dependents. The 30 percent deduction is available in the case of self-insurance as well as commercial insurance”. In order for the exclusion to apply, the arrangements must be insurance and there must be adequate risk shifting, i.e., insurance must shift the risk of economic loss from the insured to the insurance program and must distribute the risk of loss among the participants.

These rulings are significant because partners are not “employees,” and thus they are not eligible for the IRC 105(b) gross income exclusion of medical expense reimbursements or the IRC 106(a) gross income exclusion for employer-provided health coverage. Also unlike employees, partners may not pay group health insurance premiums on a pre-tax basis through IRC 125 cafeteria plans.

Although a Private Letter Ruling (PLR) applies only to the party to whom it is addressed, a PLR provides an indication of how the IRS interprets certain issues. 

For copies of the Private Letter Rulings, click on the links below:

http://66.77.65.231/pub/irs-wd/0007025.pdf

http://www.irs.gov/pub/irs-wd/0704017.pdf

This notice provides guidance on rollovers from Health Flexible Spending Arrangements (FSAs)  and Health Reimbursement Arrangements (HRAs) to Health Savings Accounts (HSAs) under the amendments to the Internal Revenue Code by section 302 of the Health Opportunity Patient Empowerment Act of 2006 (HOPE) included in the Tax Relief and Health Care Act of 2006, enacted on December 20, 2006. This guidance also provides transitional relief for rollovers completed before March 15, 2007.

The permanent guidance on rollovers from FSAs and HRAs to HSAs is effective beginning December 20, 2006 through December 31, 2011.

Under HOPE the new rules provide, in limited circumstances, certain amounts in a health FSA or HRA to be rolled over into an HAS (qualified HSA distribution).  Under the new rules all of the following conditions must be satisfied in order to receive favorable tax treatment on the rollover amount:

By plan year end -

• The plan must be amended
• The employee must elect the rollover
• The year-end balance must be frozen

The funds must be transferred by the employer within two and a half months after the end of the plan year and result in a zero balance in the health FSA or HRA.

Under the transitional relief for amounts remaining at the end of the 2006 plan year, however,

• There is no requirement to freeze the year-end balance in the health FSA or HRA and
• The amendment, election, and transfer must be completed by March 15, 2007.  

The permanent rule for individual with a zero balance in their general purpose health FSA on the last day of the plan year is – the individual does not fail to be an eligible individual as of the first day of the immediately following health FSA plan year because of coverage during a health FSA grace period.

Before implementing the FSA rollovers, consider some of these more complicated administration issues that Notice 2007-22 has created:

• The employer must amend the health FSA or HRA written plan document and SPD prior to allowing the rollovers. 
  
•  Even if qualified HSA distribution reduces the balance of an FSA or HRA to zero, the health FSA or HRA coverage does not end.  Therefore, if employee has a general purpose FSA and requests a mid-year rollover that zeros out the account balance, the employee is still not eligible for an HSA until the end of the plan year.
  
• An employee who begins HDHP coverage after the first day of the month is not an eligible individual until the first day of the next month.  Thus, if an employee begins HDHP coverage after the first day of the month, any qualified HSA distributions on behalf of the individual made before the first day of the next month is included in the employees income and subject to an additional 10 percent tax.
  
• If an employee elects to rollover any health FSA balance at the end of the plan year to an HSA, then the employee cannot submit any additional claims after end of plan year, regardless of when the underlying expense was incurred, nor can any claims be paid after the end of the plan year, even if they were incurred and submitted before the rollover of funds from the FSA to HSA.

Example:  Employer Y has a calendar year general purpose health FSA with a grace period ending on March 15, 2008.  Employer Y offers the employees the option of electing a HDHP coverage for the plan year beginning January 1, 2008.

Before January 1, 2008, Employer Y amends the health FSA to allow for qualified HSA distributions.  The amended plan allows an employee electing HDHP coverage to also elect to have any health FSA balance at year-end, determined on a cash basis, contributed directly to an HSA trustee for the employee.  For this purpose, the year-end balance is the balance of the health FSA without regard to any expenses incurred but not paid.  Under the amendment, if any employee elects the qualified HSA distribution, the employee cannot submit any additional claims after December 31, 2007, regardless of when the underlying expense was incurred, nor are any claims paid after December 31, 2007 even if submitted prior to December 31, 2007.

The notice contains many examples of the permanent and transitional guidance and how to apply the rules.

For a complete copy of the notice, click here.

The IRS released Revenue Ruling 2006-57 on November 20, 2006.  This ruling provides guidance to employers on the use of smartcards and debit cards to provide qualified transportation fringe benefits under section 132 (f) of the Code.

The effective date of this revenue ruling is January 1, 2008.  Employers and employees may rely on this revenue ruling with respect to transactions occurring prior to January 1, 2008. 

The guidance did not address use of electronic payment cards for parking reimbursement plans under Code section 132. 

In brief, the guidance does address three permissible programs. 

First, the use of smart cards; second the use of terminal-restricted debit cards. 

Both of these cards are considered vouchers and require no substantiation requirements.

And third, the use of MCC restricted debit cards where:

The card cannot be used for the first month and the purse value is funded only by  reimbursements for substantiated transit  expenses that have been incurred, rather than based on salary reduced contributions.  

DataPath is currently reviewing this guidance and will keep you posted. 

Click here to see the full text of the Revenue Ruling.

The IRS has released Notice 2007-2. This Notice provides transition relief with respect to the use of debit cards at certain merchants.

Click here to read the Notice.

The IRS has issued final rules that govern how plan administrators may use electronic media to provide various required notices.  New Treasury Regulation section 1.401(a)-21 implements provisions in the Electronic Signatures in Global and National Commerce Act (E-SIGN) that require electronic records and signatures to be given the same legal effect as their paper equivalents.  The new regulation applied to notices provided and participant elections made on or after January 1, 2007.

The new rules apply to certain communications made through a web site, e-mail, or telephone (IVR). These communications include most notices and elections made under:

• Tax qualified 401(a), 403(b), and SIMPLE retirement plans;
• IRAs, including Roth IRAs under Code section 408A;
•  Accident or health plans under Code section 104(a)(3) or 105;
• Code Section 125 Cafeteria Plans;
• Educational Assistance programs under Section 127;
• Qualified Transportation Fringe Benefit plans under Code section 132; and
• Health Savings Accounts under Code section 223.

For the full text of the guidance, click here.

The IRS has released Notice 2004-16 on March 1, 2004.

Under Code 6041 persons making payments directly to health care providers are required to report miscellaneous compensation to the IRS, enabling it to reconcile information provided by the taxpayers on their income tax returns.  Consequently, health FSAs making payments directly to medical care providers of $600 or more in any calendar year are required to file Form 1099-MISC.  In 2003, Congress amended Code 6041 to provide that Form 1099-MISC reporting requirements do not apply to payments made from health FSAs and HRAs to medical service providers after December 31, 2002. 

Notice 2004-16 provides that certain information reporting requirements of Rev. Rul. 2003-43, 2003-21 I.R.B. 935, will not apply to payments made pursuant to flexible spending arrangements (FSAs) or health reimbursement arrangements (HRAs) prior to January 1, 2003. The 1099-MISC reporting requirement was not a problem for traditional health FSAs that reimburse participants after medical services were provided. 

The 1099-MISC reporting requirement had been a concern; however, for health FSA and HRAs that occasionally paid the medical service providers directly such as those that use electronic payment cards. This Notice effectively eliminates the 1099-MISC reporting requirements for traditional health FSAs or HRAs and those that use electronic payment cards, allowing such plans to make direct payment to providers.

To read IRS Notice 2004-16, click here.