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Have an HRA? Deadline for Patient-Centered Outcomes Trust Fund Fee Looms

Below I am re-publishing a blog post I wrote last July (with edits and updates) regarding the “Patient Centered Outcomes Trust Fund” fee that is assessed against employers who have health reimbursement arrangements (HRAs).

The only change for this year is that the fee is now $2 per person (it was $1 per person last year).

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Originally published July 15, 2013. Edits and updates are in italics

If you have a health reimbursement arrangement plan (HRA, sometimes called a “Section 105 plan”), you probably owe a “Patient-Centered Outcomes Trust Fund Fee.”

Most people reading this blog post are probably saying, “What the heck is that?”.

The Patient-Centered Outcomes Trust Fund Fee is part of the Affordable Care Act. The fee is imposed on businesses or insurance companies at a rate of $1 $2 per participant in a health plan. A “health plan” of course includes traditional health insurance plans, but it also includes HRAs.

(Side note: on an employer-provided health insurance policy [not an HRA], whether the employer or the insurance company owes the fee depends on the nature of the plan; I am not an expert on health insurance plans so I won’t get into that here.) Updated to add: in most cases, the employer will NOT owe a fee on the insurance policy itself.

Back to HRAs: for purposes of this fee, an HRA is considered a health plan, thus making HRAs subject to the fee.

Here’s what’s annoying for businesses with an HRA: there’s no exemption for small businesses — and almost all HRAs (at least that I deal with) are with small businesses, oftentimes sole proprietors who have hired their spouse.

Updated to add: HRAs may be dying out for many small businesses because of other changes to HRA rules

So you have a sole proprietorship. You hired your spouse and you set up an HRA because of the tax advantages (self-employment tax savings) of running medical expenses through the HRA as deductible business expenses via your spouse. Before July 31, you’ll need to fill out a Form 720 and send a $1 $2 check to the U.S. Treasury ($1 $2 x the number of participants in the HRA).

This is insane, of course. An abject waste of a small business’s time. But it’s what the Affordable Care Act calls for.

Certainly a $1 or $2 fee is no reason to eliminate your HRA. But it’s yet another piece of paperwork to keep track of and another form to fill out.

ROBS Transactions – Be Very Careful of Using Retirement Funds to Start a Business

True scenario that happened a couple of years ago:

A client asked the following: I have $20,000 in a retirement account with a former employer. My husband wants to start a new business. We were thinking that he could hire me as an employee, and then form a retirement plan under the business.

I would transfer the money from my old retirement account into my husband’s company’s retirement plan and purchase stock in my husband’s company through the plan. This would give him startup funds without having to pay taxes on the $20,000. Will this work?

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This type of transactions is called a “ROBS” transactions (ROBS = Rollovers as Business Startups). Theoretically, it can work.  

The key word is “theoretically.”  There is a risk that the IRS could place ROBS on the list of “abusive tax transactions.”  ROBS are not on that list yet, but the IRS has issued guidance that states that ROBS are on a watch list.
There are many issues:
  1. Valuation. You’d have to figure out some way of valuing the stock so you knew how much your account was worth.
  2. Getting cash out when you want it or need it. What if your account balance is higher than the cash the company has in the bank when you’re ready to take your money out?
  3. What if the company is a flop? You’ve just lost your retirement account.
  4. What if the business needs to hire employees someday? Non-discrimination rules apply to retirement plans, meaning you can’t have special benefit programs just for the owner and his or her spouse. You’d have to let the other employees into the plan and probably give them access to purchasing company stock.
  5. Issues with UBIT (“Unrelated Business Income Tax”), which could be assessed against the retirement plan.
ROBS are workable in theory, but the transaction and maintenance of the plan need to be done just right. Attorney fees would be steep. 

What I Told the Client

I told them all of these things. I then went on to say that it made more sense, if they really wanted to use the retirement funds to start the business, to just withdraw the money and pay the taxes and penalties on the $20,000. Doing this wouldn’t have been a great option, either. But the taxes and penalties were likely to be in the same neighborhood as the compliance costs over time.

In the end, after learning of the complications, the client dropped the idea entirely and went on to find other means of getting the business off the ground.

HRAs and the Affordable Care Act

An insurance agent recently asked me the following question: can a small business that currently offers insurance to its employees drop the insurance and instead form a Health Reimbursement Arrangement (HRA, sometimes called a “Section 105 plan”) to reimburse employees for medical expenses?

The short answer to the question is: NO.

Background

HRAs have existed since the 1950s. Under an HRA, an employer reimburses employees for medical expenses, up to a certain dollar amount. For example, an employer could say that they will reimburse up to $1,000/year of an employee’s medical expenses.

In the past, HRAs could be offered as a stand-alone plan, or as an additional benefit in addition to employer-provided health insurance.

The Affordable Care Act has made stand-alone HRAs a thing of the past (with 1 exception).

The New Landscape

Effective January 1, 2014, an employer can only offer an HRA if 1) the employer also offers group health insurance, and 2) only employees enrolled in the group plan can be a part of the HRA.

Exception

An employer with one employee (such as a sole proprietor who employs his or her spouse) can have a stand-alone HRA without having group health insurance. If a business has 2 or more employees, the business cannot have a stand-alone HRA. The penalty for non-compliance is $100/employee/day.

IRS Guidance

IRS Notice 2013-54 provides further details.

As with anything relating to the Affordable Care Act, there are nuances and oddities that are impossible to fully cover in a blog post. If you have an HRA, you are best advised to seek the counsel of your accountant or a third-party administrator for guidance on your specific situation.

Things Tax Preparers Say: S-Corporation Compensation

In the tax world, the topic of S-corporations and the salary that needs drawn by the owner(s) of the S-corp is like the wild west. S-corps can be great for self-employed people to save on self-employment taxes. But too many business owners — and their accountants — treat S-corps like a magic wand that can just make taxes disappear completely.

Here’s an example.

Scenario: a friend of mine (who’s not a client) owns a business. The business is a startup that generated about $10,000 of net profit in its first year. The owner took draws of about $10,000 from the corporation during the year.

He asked his CPA about whether some of those draws might need to be called a salary. The CPA told him the following nuggets of “wisdom”:

  1. You don’t need to worry about taking a salary because you’re too small for the IRS to care about, and
  2. You don’t need to pay yourself a salary until your net income gets to $100,000. Then you can just do a 50/50 split between salary and shareholder distributions.

Oh my. Where to begin?

  1. Tax law requires owners of corporations who provide services to the corporation to pay themselves a “reasonable salary.” The “reasonable” part is never defined but the law is quite clear about withdrawals from a business by an owner needing to be called “salary” (up to a “reasonable amount”). (Broadly speaking, see Code Sections 162, 3121, 3306, the regulations under those sections, Revenue Ruling 74-44 and a plethora of court cases).
  2. There is no such thing as being “too small for the IRS to care about.” It is true that the audit risk is lower for businesses with lower income. But if you’re unlucky enough to get audited, you can’t tell the IRS “I didn’t think I’d get audited” and expect that to fly!
  3. The CPA’s second statement about not needing to pay a salary until net income is $100,000 is completely wrong, as is his “50/50 split” statement. There is no magical threshold or magical formula. The concept of wages paid to corporate owners is based on how much the owner is withdrawing from the business, what sort of services the owner provides to the business, and determining what “reasonable” compensation is for those services.

I told my friend that his CPA was leading him astray, and that the CPA has no legal basis for saying these things. The only possible basis the CPA could have is “I’ve done it this way with other clients before and the IRS has never questioned it.”

 

I’m sure the CPA’s small business clients think he’s a hero who’s found the secret sauce for saving thousands of dollars in taxes. But this is one of those “it works great til it doesn’t” situations. Someday the CPA or one of his clients will get burned.

Now … I think there may be ways my friend could legitimately say his salary the first year of operation was $0 even though he took out $10,000. More on that in a future blog post.

Accounting for the Work Opportunity Credit on an Iowa Tax Return

Question: does Iowa recognize the Work Opportunity Credit?

Answer: no, but they do allow a deduction equal to the amount of credit claimed.

Analysis and Background

The Work Opportunity Tax Credit (WOTC) is a federal tax credit designed to reward employers for hiring people from certain targeted demographics. I went into more detail about the credit in this blog post.

Iowa does not recognize the WOTC; it’s only available on federal tax returns. However, all is not lost on your Iowa return.

How to Handle on the Iowa Return

On the federal tax return, the amount of WOTC claimed reduces the amount of deduction you can take for wages paid. For example, if you pay $20,000 of wages and qualify for a $2,000 WOTC, your deduction for wages paid is reduced to $18,000.

On your Iowa tax return, this “lost” deduction of $2,000 is allowed as an adjustment to income.

So, you don’t get a credit with Iowa, but you do get to take a deduction equal to the amount of WOTC claimed on the federal return.

Glossary of Tax Terms: Depreciation

There’s no easy way to explain depreciation, but here’s a try!

For tax purposes, depreciation is a deductible expense relating to the purchase of assets used in a business or rental activity. Assets are things that have a useful life of more than one year, so generally we’re talking about buildings and equipment.

Tax law does not allow for a full deduction right away for purchasing assets. Instead, the cost is spread out over the useful life of the asset. (Note: actually, tax law does allow for full deductions right away for purchasing assets if the taxpayer employs “bonus depreciation” or “Section 179 expensing.” But those are different topics for a different blog post.)

The IRS determines the useful life of an asset. For example, the IRS assigned a useful life of 5 years to computers. Meaning the purchase of a computer is deducted over 5 years. This is true even if a business only intends to use the computer for 3 years.

This concept is different from “generally accepted accounting principles” which govern financial statements. For GAAP purposes, an asset is depreciated over its useful life, and the company gets to determine that useful life. So in our computer example in the last paragraph, the depreciation deduction would be spread over 3 years for GAAP.

In practice, most of the small businesses I deal with use Section 179 expensing to deduct the full asset cost in the year of purchase. Or the business will take bonus depreciation. (Again, these two topics are another blog post for another day!) But sometimes Section 179 isn’t an option, and bonus depreciation may not result in 100% expensing right away, so it’s useful for business owners to have an understanding of depreciation.

The Affordable Care Act and Small Businesses

(NOTE: This is a very, very, very basic overview of the Affordable Care Act as it relates to small businesses. I will be going into more detail in other blog posts in the months to come.)

My small business clients are, universally, afraid of the Affordable Care Act.

So am I.

I learn new things about the ACA on a weekly basis. Typically it’s something I’ve stumbled across while researching something else.

It’s scary, because I always wonder what else I’m missing. I’ve researched the ACA, given presentations on it, taken continuing education, and still I learn new and surprising things on a weekly basis.

Scary.

But the typical small business can breathe easy regarding one aspect of the ACA: the ACA does not require your business to offer health insurance to your employees.

50 or More Full-Time Equivalent Employees — Algebra Time!

The ACA requires companies with 50 or more “full-time equivalent” employees to offer health insurance. This requirement starts in 2016 for companies with 50-99 employees, and 2015 for companies with 100 or more.

If your business is nowhere near 50 employees, you’re in the clear.

But if you are close to 50 or above 50, how do you know if you’re affected?

Sharpen your pencils — it’s algebra time!

The definition of a full-time employee for this part of the ACA is: any employee who works 30 or more hours per week.

So, you’ll need to go through your entire workforce and determine the average number of hours worked per week. Employees who work 30 or more hours/week count as 1 full-time employee. Employees who work less than 30 hours/week count as a fraction of 1 full-time employee.

For example, an employee who works 20 hours/week would count as 0.67 of a full-time employee.

(This is a gross oversimplification of the process. If this affects you, consult with your accountant and/or insurance person to get more details about things like the “look-back period” and other things you need to take into consideration.)

After you’ve completed this exercise, you add up the “full-time equivalent” number assigned to each employee. If you reach 50 or more, you’re required to provide insurance or pay a penalty.

ACA Affects Us All

That’s not to say the ACA doesn’t affect small businesses at all. It affects all of us in some way, because of the “individual mandate.” But that’s a different blog post for a different day.

Financing a Small Business: 4 Items to Remember

In December I had the honor of serving as a panelist for a discussion about small business financing, how to deal with bankers, sources of funding, etc.

In preparing for the panel discussion, I wrote down 4 key points that I wanted to make about financing, and I wanted to share them here:

One: There’s going to be paperwork. Learn to deal with it.

Some of my small business clients like to rant and rave to me about the fact that there’s paperwork and bureaucracy and laws and regulations at every step of everything they want to do.

My response is always “yep, there sure is.”

I’ve seen business owners, who had nothing to hide from the bank, throw their hands up and walk away from bank loans because the bank was asking questions and wanted to see financials and tax returns.

Guess what: there’s going to be paperwork and questions when you’re asking a bank for money. Deal with it.

Two: Work with your accountant.

Your accountant probably knows several good bankers (I know I do). Use your accountant as a resource for getting introduced to bankers who can help you with financing.

Three: Tell your accountant about major expenditures BEFORE you spend the money.

This is important so your accountant can advise you of the tax consequences and help you plan.

One example: I once had a client spend tens of thousands of dollars constructing a building, thinking that all of the money they were investing would be fully deductible that year. They were disappointed to learn that tax law considers a building to be commercial property, and most of their costs needed to be depreciated over 39 years rather than being fully deductible in the first year.

If they had consulted with me ahead of time, they may have made a different decision with their money.

Talk to your accountant before you spend the money. Once the transaction is completed, there’s not much I can do to change the tax consequence.

Four: Don’t spend money just to get tax deductions.

You’re wasting money if you make purchases just to get tax deductions. Make business purchases based on need, rather than solely the fact that you might get a tax deduction. Tax deductions save you cents on the dollar. So if your tax rate is 30%, you’re saving 30 cents on every dollar you spend on business expenses.

Or to put it another way: you’re not really “saving” 30 cents, you’re losing/spending 70 cents.

The tax deduction is great if you need the things your purchasing. But you’re wasting money if you’re just spending money to try to get deductions.

Small Businesses — Review Those Benefit Programs

When was the last time your small business reviewed the benefit programs your business offers?

Whether it’s health insurance, a cafeteria plan, a retirement plan or a health reimbursement arrangement, it’s a good idea to review those programs now and then.

As you review these programs, take into consideration these 3 things:

  1. Cost. This one is obvious and fairly self-explanatory. How much money are you spending on your benefit program? Is it worth it? What alternatives are available?

  2. Mechanics. By this I mean, look at how complicated it is for you to maintain. Is it eating up large chunks of your time? What sort of government paperwork to you have to file? What sort of compliance issues do you face? Are there simpler alternatives?

  3. Employee notices. If you have employees, you are probably required to give them various notices regarding the benefit programs you offer. Yes, most of these notices end up in the garbage and never get read. But you still have to hand them out. And the government typically requires that the notices contain certain specific language. When you review your benefit programs, also review your notices to make sure they’re saying what they need to say.

And of course, you should involve your accountant in these discussions.

Issuing 1099s to an Incorporated Veterinarian

It’s 1099 season! Typically a 1099 must be issued by a business that pays $600 or more to a person who provides contract labor or services to the business during the year.

An exception applies to payments made to corporations. Generally, payments to corporations do not require the issuance of a 1099. There are two exceptions to the “no 1099 to a corporation” rule:

  1. Payments made to law firms. Law firms must receive a 1099 for payments made for legal services in excess of $600.
  2. Payments made for medical services.

How about payments made to veterinarians? Do veterinarian services fall under the definition of “medical services?”

According to the IRS, the answer is … yes. Per Letter Ruling 201349013:

Generally, yes. Payments made by a taxpayer in the course of the taxpayer’s trade or business to an incorporated veterinarian must be reported to the IRS to the extent the payments aggregate to $600 or more per year. Incorporated veterinarians are not exempted from the reporting requirement by Treas. Reg. Sec. 1.6041-3(p)(1) because veterinarians are “engaged in providing medical and healthcare services” for the purposes of Treas. Reg. Sec. 1.6041-3(p)(1).

To be clear: this only applies to BUSINESSES that make payments to veterinarians in the course of conducting business (so farmers, ranchers, pet stores, zoos, etc.). Private citizens who take the family pet to the vet don’t need to issue a 1099 to the vet.

It may seem strange to think that veterinarians would fall under the definition of “medical and healthcare services,” but the IRS says it’s consistent with prior rulings in which the phrase “medical and healthcare services” is not necessarily limited to services performed on humans:

Congress and the IRS have historically included veterinarians in the field of medical and healthcare services, and specifically excluded veterinarians when exclusion was intended. For example, in Rev. Rul. 91-30 the IRS determined that veterinarians are in the “field of health” and should be included within the meaning of “similar healthcare providers” akin to doctors, nurses, and dentists, for purposes of defining a Personal Service Corporation. As an example where Congress intended to exclude veterinarians from a consideration of what is considered “medical, Congress specifically limited the definition of “medical device” in IRC Sec. 4191(b)(1) to devices “intended for humans.” Under Treas. Reg. Sec. 1.6041-3(p)(1) the language does not limit the terms “medical” or “healthcare” to services intended to treat humans. Accordingly, we conclude that a corporation providing veterinary services is “engaged in providing medical and healthcare services,” for purposes of Treas. Reg. Sec. 1.6041-3(p)(1), and is therefore not excepted from the information reporting requirement of IRC Sec. 6041 as a corporate payee.

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