You have five employees. You can't afford a group health plan, so you do the generous thing: you reimburse each worker $500 a month toward whatever individual policy they buy on their own. Everyone is happy — until you learn that this exact arrangement can trigger a federal excise tax of $100 per day, per employee. For five workers over a full year, that is $182,500. For a kindness.
This is not a hypothetical trap. The IRS spelled it out more than a decade ago, and small employers keep walking into it because the rule is genuinely counterintuitive: reimbursing employees for health insurance can itself be an illegal health plan.
The Rule That Turns Good Intentions Into a Group Health Plan
Under IRS Notice 2013-54, an arrangement in which an employer reimburses employees for individual-market premiums — or pays those premiums directly — is called an employer payment plan. And an employer payment plan is, in the eyes of the law, a group health plan.
That classification is everything. Group health plans must satisfy the Affordable Care Act's market reforms, including two requirements an employer payment plan structurally cannot meet:
- No annual dollar limits on essential health benefits (Public Health Service Act section 2711). Your $500-a-month reimbursement is, by definition, an annual dollar limit.
- Certain preventive care with no cost sharing (PHS Act section 2713). A fixed reimbursement does not provide preventive services at all.
The notice also closes the escape hatch you might reach for: an employer payment plan cannot be integrated with the individual policies employees buy to satisfy these reforms. The arrangement stands alone, fails alone, and is penalized alone.
What Counts as an Employer Payment Plan
More arrangements fall into this bucket than most owners realize:
- Reimbursing employees, pre-tax or after-tax, for individual premiums — even through a Section 125 cafeteria plan
- Paying an employee's marketplace or COBRA premiums directly to the insurer
- Offering "cash in lieu" of coverage only if the employee shows proof of individual coverage — conditioning the cash on insurance makes it a payment plan
- Reimbursing out-of-pocket medical expenses outside of a compliant HRA or FSA design
The common thread is conditionality: money that flows because of health coverage is a health plan. Money that flows regardless of coverage is just compensation, as discussed below.
The $100-a-Day Math Under Section 4980D
Section 4980D of the Internal Revenue Code imposes an excise tax of $100 per day per affected individual for each day a group health plan fails the market reforms. That is $36,500 per employee per year — and it scales linearly with headcount and time.
A few features make this penalty unusually dangerous:
- It applies regardless of employer size. There is no small-business exemption. A three-person shop faces the same per-head rate as a corporation.
- You are supposed to report it yourself. The tax is self-reported on Form 8928, due by the deadline for your federal income tax return — and a filing extension for the return does not extend the Form 8928 deadline.
- There are floors, not just ceilings. Failures due to reasonable cause (and not willful neglect) carry minimum excise taxes — generally $2,500, rising to $15,000 when failures are more than de minimis. Unintentional failures are capped at the lesser of 10% of what you spent on group health plans the prior year or $500,000 — a cap that helps large employers far more than small ones.
- The old transition relief is long gone. The IRS gave small employers a grace period that ended in mid-2015. Every plan year since then has been fully exposed.
Who Is Actually Exempt
A short list of arrangements genuinely sits outside these rules:
- Plans covering fewer than two participants who are current employees — for example, a retiree-only plan or an owner-only arrangement with no rank-and-file participants
- Excepted benefits such as standalone dental, vision, and most health FSAs that meet the excepted-benefit conditions
- Coverage for S corporation shareholders owning more than 2%, whose premiums are handled through the S corp's wage-inclusion rules rather than the group-plan reforms — but note this covers the owners, not your other employees
If your arrangement reimburses even one rank-and-file employee's individual premiums, none of these shields you.
The Three Legal Ways to Help Employees With Health Costs
The law does not require you to offer nothing. It requires you to use one of the sanctioned vehicles — or to give unconditional compensation. Here they are, from most to least structured.
1. QSEHRA: The Small-Employer Reimbursement Account
The Qualified Small Employer Health Reimbursement Arrangement, created by Congress in late 2016, is the purpose-built fix for exactly this problem. If you have fewer than 50 full-time-equivalent employees and offer no group health plan, you can reimburse employees tax-free for individual premiums and medical expenses.
Key rules for 2026:
- Caps: $6,450 per year for self-only coverage, $13,100 for family coverage (adjusted annually for inflation)
- Same terms for all eligible employees, with only age and family-size variations allowed
- Employees must carry minimum essential coverage to receive reimbursements tax-free
- Written notice to employees at least 90 days before the plan year begins
One wrinkle to warn employees about: QSEHRA reimbursements reduce marketplace premium tax credits dollar for dollar, and can eliminate them. An employee who assumed they would stack your reimbursement on top of a subsidy needs to hear this before open enrollment, not at tax time.
2. ICHRA: The Flexible Option at Any Size
The Individual Coverage HRA, available since 2020, works for employers of any size and carries no statutory contribution cap. You define employee classes (full-time, part-time, seasonal, salaried, hourly, and others — eleven classes in total), set a monthly allowance per class, and reimburse premiums for individual coverage plus medical expenses.
ICHRA administration is heavier: employee classes must be genuinely distinct, larger employers must navigate affordability calculations that affect premium tax credit eligibility, and notices are required. But for a growing business that has outgrown QSEHRA's headcount limit or wants to vary contributions by class, it is the compliant path.
3. The After-Tax Raise: The Only Safe Workaround
If formal HRAs sound like too much machinery, there is a simpler option: pay employees more, unconditionally. A raise, bonus, or stipend that employees may spend on anything — with no requirement to buy insurance and no request for proof of coverage — is not a group health plan at all. It is wages: deductible to you, taxable to them.
The discipline required is entirely about what you don't do:
- Don't call it a health benefit in the offer letter or handbook
- Don't condition it on maintaining coverage or showing an insurance card
- Don't vary it based on whether the employee enrolls somewhere
- Don't run it pre-tax through a cafeteria plan
The moment the money depends on insurance, you have rebuilt the employer payment plan. Keep the raise genuinely unconditional and the tax treatment follows the label: ordinary compensation, reported on Form W-2 like any other pay.
Common Mistakes That Trigger the Penalty
Running reimbursements through a Section 125 plan. Some employers assume that routing individual-premium reimbursements through a cafeteria plan legitimizes them. It does not — the underlying arrangement still fails the market reforms, and the salary-reduction structure adds a second compliance problem.
Paying the insurer directly. Writing the check to the insurance company instead of the employee changes nothing. Direct payment of individual premiums is explicitly listed as an employer payment plan.
"Show me your policy and I'll cover it." Cash conditioned on proof of individual coverage is the fact pattern the agencies specifically call out. The condition is what creates the plan.
Assuming payroll software handles it. Most small-business payroll setups will happily process a recurring "health stipend" line item with no warning that the design is noncompliant. The software records what you tell it; the compliance judgment is yours.
Forgetting the S corp owner-employee rules. If you run an S corporation, premiums for shareholders owning more than 2% must be included in their W-2 Box 1 wages (deductible by the corporation, and deductible by the shareholder as self-employed health insurance if the plan requirements are met). Getting this backward — excluding owner premiums from wages — is a separate, common audit adjustment.
What to Do If You Already Have an Employer Payment Plan
If you recognize your current arrangement in this article, treat it as urgent but fixable:
- Stop the noncompliant reimbursements. Each additional day of the arrangement accrues additional exposure.
- Replace it with a compliant vehicle — stand up a QSEHRA or ICHRA, or convert the dollars to unconditional compensation.
- Talk to your tax advisor about Form 8928. Past exposure may need to be quantified and reported; reasonable-cause relief and the statutory caps exist precisely for employers who fix mistakes voluntarily.
- Document the correction. Contemporaneous records of when the old arrangement ended and what replaced it are your best evidence of good faith.
Track Every Health Dollar Like an Auditor Will Read It
Whichever compliant path you choose, the bookkeeping discipline is the same: health-related payments must be traceable from authorization to employee to tax form. Keep the HRA plan document, the annual employee notices, each reimbursement substantiation, and the corresponding payroll records in one place. For after-tax raises, keep the offer language showing the pay was unconditional — that document is what separates wages from a group health plan if questions ever arise. Clean, separate ledgers for benefits versus compensation turn a nerve-wracking inquiry into a ten-minute file pull.
Keep Your Benefits Bookkeeping Audit-Ready
Health benefit compliance lives or dies in your records — plan documents, notices, reimbursements, and payroll entries all cross-referencing cleanly. Beancount.io provides plain-text accounting that gives you complete transparency and control over your financial data, so every benefits dollar is traceable and version-controlled. Get started for free and see why developers and finance professionals are switching to plain-text accounting.
