Partners participating in self-funded health plan.

• Author: Josephs, Stuart R.

Under Sec. 104(a)(3), amounts received through accident or health insurance (or through an arrangement having the effect of accident or health insurance) for personal injuries or sickness generally are excluded from income. The parenthetical language was added by the Health Insurance Portability and Accountability Act of 1996 (HIPAA), for tax years beginning after 1996. The 1996 "Blue Book," covering the HIPAA and other tax legislation enacted in the 104th Congress, explains this statutory addition (at p. 334):

HIPAA also provides that payments for personal injury or sickness through an arrangement having the effect of accident or health insurance (and that is not merely a reimbursement arrangement) are excludable from income. For the exclusion to apply, the arrangement must be insurance (e.g., there must be adequate risk shifting). This provision equalizes the treatment of payments under commercial insurance and arrangements other than commercial insurance that have the effect of insurance. Under this provision, a self-employed individual who receives payments from such an arrangement can exclude the payments from income.

In Letter Ruling 200007025, a partnership offered a group health plan to both its partners and its nonpartner employees. The plan consisted of a self-funded component for its eligible nonpartner employees and an insured component for its eligible partners. As of June 1, 1999, there were over 200 partners participating in the insured component and over 900 nonpartners participating in the self-funded component.

The partnership intended to amend the plan to eliminate the insured component and cover all eligible persons (including eligible partners) under one self-funded health plan. After this amendment, the eligible medical expenses of participating partners and nonpartner employees would be reimbursed by the plan from a dedicated account funded with premium payments made by these participants and with contributions made by the partnership.

The amount of the premium would be determined by the partnership, before the start of each plan year, in consultation with unrelated independent plan administrators. The premium would be based on the past claims experience of participants in the aggregate. The partnership would charge each participating partner and nonpartner employee a pro rata share of the plan's projected claims and administrative costs. Partners and nonpartners would be charged the same premium, but premiums would...