Discover the ins and outs of Health Reimbursement Arrangements (HRA) and how to navigate benefits with expert insights from J.R. Martin & Associates.

What Is A Health Reimbursement Arrangement (HRA)?

As a business owner, you are likely well aware of how important it is to attract and retain top talent. Without skilled employees, sustaining productivity, fostering innovation, and driving business growth can be challenging. Although offering competitive compensation packages is an obvious way to attract top talent, it’s not solely about salaries; benefits also play a crucial role.

Comprehensive benefits packages are essential for reducing employee turnover and fostering job satisfaction. Among the various benefits plans available, one notable option is the Health Reimbursement Arrangement (HRA) plan. The following is an overview of what an HRA entails and how it can benefit both your business and its employees.

Understanding The Basics Of HRA

An HRA is an employer-funded health benefit plan designed to reimburse employees for out-of-pocket medical expenses. The medical expenses that can be reimbursed include:

• Insurance premium payments
• Co-pays
• Payment toward a deductible
• Routine doctor visits
• Hospital expenses
• Dental care
• Vision care
• Prescription drugs
• Over-the-counter medicine and drugs
• Blood glucose monitors

HRA plans provide a flexible and tax-advantaged solution, allowing you to manage healthcare costs effectively while offering valuable support to your employees. Unlike traditional health insurance, HRAs are not pre-funded, and reimbursements occur only when employees incur qualified medical expenses, thereby offering customization and control over healthcare spending.

HRA Vs. HSA

A Health Savings Account (HSA) is a tax-advantaged savings account designed for individuals enrolled in a high-deductible health plan (HDHP). HSAs let individuals save and pay for qualified medical expenses with pre-tax dollars. Contributions to an HSA can be made by both the employee and the employer up to the annual limits set by the IRS.

The funds in an HSA roll over from year to year and can be invested, providing the potential for growth over time. Additionally, the HSA is owned by the employee, meaning the account remains with them even if they switch jobs or retire. Withdrawals from an HSA for qualified medical expenses are tax-free, offering a triple tax advantage: tax-deductible contributions, tax-free earnings, and tax-free withdrawals.

In contrast, an HRA is a health benefit plan funded by the employer that reimburses employees for their out-of-pocket medical expenses and, in some cases, health insurance premiums. Unlike an HSA, only employers can contribute to an HRA, and the employer retains control over the funds.

HRAs do not require a high-deductible health plan for eligibility. They can be paired with various types of health insurance plans. Reimbursements from an HRA are tax-free for the employee, and as the employer, you can deduct these reimbursements as a business expense. The funds in an HRA do not belong to the employee, and any unused funds typically revert to the employer. However, some plans may allow limited rollover at the employer’s discretion.

Types Of Health Reimbursement Arrangements

HRAs are versatile, employer-funded health benefit plans designed to reimburse employees for qualified medical expenses. Because healthcare needs and employment structures vary, different types of HRAs have been developed to cater to diverse requirements. Understanding the various kinds of HRAs is essential for you and your employees to maximize the benefits these plans offer. The following are the different types of HRAs:

Qualified Small Employer HRA (QSEHRA)

A Qualified Small Employer Health Reimbursement Arrangement (QSEHRA) is a type of HRA designed for small businesses. Introduced under the 21st Century Cures Act in 2016, QSEHRAs allow small employers to offer healthcare benefits to their employees without sponsoring a traditional group health insurance plan. The following are the key features of a QSEHRA:

• Eligibility: The plan is available to employers with fewer than 50 full-time equivalent employees; it cannot be offered alongside a group health plan.
• Funding: The plan is employer-funded with annual IRS-set contribution limits ($6,150 for employee-only coverage and $12,450 for family coverage in 2024).
• Usage: It covers qualified medical expenses, including insurance premiums, and is tax-free for employees with minimum essential coverage; funds do not typically roll over from year to year.

Individual Coverage HRA (ICHRA)

An Individual Coverage Health Reimbursement Arrangement (ICHRA) is a type of HRA introduced in 2020 that allows employers of any size to reimburse the health insurance premiums of their employees as well as other qualified medical expenses. Here are the key features and benefits of an ICHRA:

• Eligibility: The plan is available to employers of any size; employees must have individual health insurance or Medicare.
• Funding: The plan allows employer-determined contributions with no specific IRS limits; funds can be used for individual health insurance premiums and qualified medical expenses.
• Flexibility: Employers can tailor benefits based on employee classes (e.g., full-time, part-time) and decide on rollover options.

Group Coverage HRA (GCHRA)

A Group Coverage Health Reimbursement Arrangement (GCHRA), often referred to as an Integrated HRA, is designed to work alongside a traditional group health insurance plan. It allows employers to reimburse employees for qualified out-of-pocket medical expenses not covered by the group health plan. Here are the key features and benefits of a GCHRA:

• Eligibility: The plan is available to employers of any size with group health insurance plans; employees must be enrolled in the group plan.
• Funding: It allows for employer-determined contributions with no specific IRS limits; funds reimburse out-of-pocket medical expenses not covered by the group health plan.
• Flexibility: Employers can customize coverage and decide on rollover options for unused funds.

Other HRA Types:

In addition to the commonly known HRAs like QSEHRAs and ICHRAs, there are several other types of HRAs tailored to meet specific needs and circumstances. These additional HRA types provide further flexibility and customization options for both employers and employees, ensuring that diverse healthcare and financial needs can be effectively addressed. They include:

• One-Person 105: A One-Person 105 HRA is an HRA specifically designed for business owners who do not have any employees other than themselves or perhaps a spouse. This type of HRA allows the business to reimburse the owner for medical expenses, including health insurance premiums, on a tax-free basis. It’s particularly beneficial for sole proprietors, partners, and shareholders owning more than 2% of an S-Corporation, offering significant tax savings on medical expenses.
• Integrated: An Integrated HRA is a type of HRA that works alongside a traditional group health insurance plan. Employers use Integrated HRAs to reimburse employees for qualified out-of-pocket medical expenses that are not covered by the group health plan. This arrangement enhances the overall benefits package by reducing employees’ out-of-pocket costs for deductibles, co-pays, and other medical expenses, providing additional financial support and flexibility.
• Traditional: A traditional HRA is an employer-funded health benefit plan that reimburses employees for a wide variety of qualified medical expenses, including deductibles, co-pays, and prescription medications. Unlike other HRAs, traditional HRAs are not tied to specific health insurance plans, offering employers and employees flexibility in how they manage and use their healthcare funds. Employers set aside a specific amount annually, and employees can claim reimbursements tax-free.
• Excepted benefit HRAs (EBHRA): EBHRAs allow employers to offer additional health benefits up to a specific annual limit ($2,100 in 2024) without requiring employees to be enrolled in the group health plan. EBHRAs cover “excepted” benefits only, such as vision, dental, COBRA (the Consolidated Omnibus Budget Reconciliation Act), and short-term limited-duration insurance premiums. They provide a way to offer supplementary health benefits while maintaining compliance with healthcare regulations.
• Standalone: A standalone HRA is not integrated with any group health insurance plan. Historically, these HRAs allowed employers to reimburse their employees for individual health insurance premiums as well as other medical expenses. However, due to regulatory changes with the Affordable Care Act (ACA), standalone HRAs have largely been replaced by other models like QSEHRAs and ICHRAs, which comply with current healthcare laws.

How Does An HRA Work?

Understanding how an HRA works is essential if you and your employees are to maximize its benefits. The process involves several important steps. Each step is crucial in ensuring the HRA’s smooth operation and effectiveness, providing financial support for healthcare costs, and maintaining compliance with regulatory requirements. The following steps illustrate how an HRA functions from start to finish.

Step 1: Design the HRA Plan with Experts & Set Reimbursement Limits

The first step involves working closely with benefits experts, insurance brokers, or third-party administrators to design the HRA plan. These professionals will help you navigate complex healthcare regulations and ensure the plan complies with relevant laws, including the ACA and IRS rules.

During this phase, you will determine the key features of the HRA, such as eligibility criteria, which types of medical expenses will be reimbursed, and any specific conditions or limitations. A crucial aspect of this step is setting the annual reimbursement limit, which defines the maximum amount each employee can be reimbursed for qualified medical expenses in a given year. This limit varies based on factors like employee class, job role, or other criteria that you will define. As the employer, you must also ensure the plan is fair and adheres to nondiscrimination requirements.

Step 2: Employee Purchases Healthcare & Submits a Claim

Once the HRA plan is in place, employees can begin purchasing healthcare services and products that qualify for reimbursement. These qualified medical expenses may include health insurance premiums, deductibles, co-pays, prescription medications, and other eligible healthcare costs.

Employees are responsible for keeping detailed records of their purchases, such as receipts, invoices, and explanations of benefits (EOBs) provided by their insurance companies. After incurring these expenses, employees must submit claims to the HRA administrator. This process typically involves completing a claim form and attaching the necessary documentation to verify the expenses. The claim form usually requires details like the date of service, type of service, amount paid, and provider information.

Step 3: Employer Reimburses Approved Healthcare Claims

The final step involves the HRA administrator reviewing the submitted claims. The administrator checks the documentation to ensure the expenses are eligible under the HRA plan’s rules and guidelines. This review process ensures completeness, accuracy, and compliance with the plan’s criteria. If the claim is approved, the administrator processes the reimbursement. If the claim is denied, the employee is notified and allowed to correct or resubmit the claim.

Once approved, the reimbursement amount is paid to the employee through direct deposit, a check, or an addition to their payroll. You must track all reimbursements for record-keeping and regulatory compliance purposes, ensuring transparency and accountability. Employees receive summaries of their HRA activity, showing the amounts reimbursed and the remaining balance for the year. The reimbursed amounts are tax-free for employees, and you can deduct these amounts as a business expense, providing financial benefits to both parties.

Who Qualifies For The Health Reimbursement Arrangement?

In general, any employee designated by the employer can qualify for an HRA. You can define eligibility criteria based on factors such as job role, employment status (full-time, part-time), or length of service. The specific criteria are outlined in the HRA plan documents. All eligible employees can use the HRA funds to pay for qualified medical expenses, such as health insurance premiums, co-pays, deductibles, and other out-of-pocket healthcare costs.

As an employer, you can also benefit from HRAs, though this depends on your company’s structure. For example:

• C-Corporations: Owners and employees can both benefit from an HRA. In a C-Corporation structure, the business is a separate legal entity, so owners are considered employees and are eligible for HRA reimbursements.

• S-Corporations: Shareholders who own more than 2% of the company and their family members are typically treated differently. These owners may still use HRA funds, but the reimbursements must be included in their taxable income, unlike for regular employees.

• Partnerships: Members of a partnership can have an HRA, but like S-Corporation owners, their reimbursements are considered taxable income.

• Sole proprietors: A sole proprietor can set up an HRA but must be cautious about tax treatment. Like partnerships and S-Corporations, the sole proprietor’s reimbursements are included in their taxable income.

Each type of business entity has specific tax implications and regulations, so it’s essential to understand these nuances and speak with a tax professional to optimize the benefits of an HRA.

Leveraging HRA Tax Benefits For Businesses

HRAs offer significant tax advantages. These benefits help reduce the overall tax burden for businesses and enhance employee satisfaction and retention by providing flexible healthcare options. Understanding and effectively utilizing these tax benefits can lead to substantial financial savings and a more robust employee benefits package.

That said, the following are the various tax advantages of HRAs and how you can strategically implement them to maximize their financial and operational benefits:

Tax Deductibility

As the employer, you can deduct contributions to HRAs as a business expense, reducing your overall taxable income and lowering your tax liability. Additionally, these contributions are exempt from payroll taxes, leading to further savings.

For employees, reimbursements from HRAs are tax-free, provided the expenses are qualified under IRS guidelines. This means that employees do not have to pay federal, state, or payroll taxes on the reimbursed amounts, effectively increasing the value of their compensation without increasing their taxable income.

No Payroll Taxes

When you contribute to an HRA, these contributions are not considered part of the employee’s wages. Therefore, they are not subject to payroll taxes, including Social Security, Medicare, and Federal Unemployment Tax Act (FUTA) taxes. By funding an HRA instead of increasing salaries, you can provide additional compensation without the added payroll tax expense.

Employee reimbursements for qualified medical expenses from an HRA are tax-free. This means that these reimbursements are not counted as taxable income for the employee and do not incur any payroll taxes. Employees benefit from receiving funds for their medical expenses without the burden of additional taxes on these amounts.

Customizable Plans

Implementing an HRA allows you to create a highly customizable health benefit plan tailored to the specific needs of your workforce. You can decide which employees are eligible for the HRA, whether by job role, employment status, or other criteria. This flexibility ensures that the benefits package can be aligned with your company’s strategic goals and financial capabilities while addressing the diverse healthcare needs of different employee groups.

You can also choose the types of medical expenses the HRA will cover. These include health insurance premiums, deductibles, co-pays, and other out-of-pocket medical costs. By defining what is reimbursable, you can design a plan that fits your budget and supports employees effectively. Additionally, you set the annual reimbursement limits, determining how much each employee can be reimbursed. These limits can vary across different classes of employees, providing a way to offer more substantial benefits to essential personnel or those with higher healthcare needs.

This level of customization helps you manage costs while providing valuable health benefits. It also allows for adjustments over time, enabling you to respond to changes in healthcare costs, business performance, and employee needs.

Healthcare Cost Control

HRAs provide healthcare cost control by allowing you to set and manage the amount of money allocated for employee medical expenses. This predictability in budgeting is one of the primary advantages of an HRA. By determining a fixed annual reimbursement limit for each employee, you can precisely forecast your healthcare expenditures, preventing unexpected costs that often arise with traditional health insurance plans.

Additionally, HRAs shift some of the cost management responsibility to employees. Since employees must pay for their medical expenses upfront and then seek reimbursement, they are more likely to be cost-conscious and make informed healthcare choices. This consumer-driven approach can lower healthcare spending as employees are incentivized to seek cost-effective treatments and services.

HRAs also offer you the flexibility to adjust coverage and reimbursement limits based on the company’s financial performance and changes in healthcare costs. You can choose which medical expenses are eligible for reimbursement, tailoring the plan to control costs while still providing meaningful benefits. This customization ensures that the funds are used effectively and efficiently, targeting specific healthcare needs without unnecessary spending.

Affordable Care Act Compliance

HRAs can help you comply with the ACA in several ways. HRAs are designed to meet specific ACA requirements, ensuring you can provide meaningful healthcare benefits while adhering to federal regulations.

Certain types of HRAs, such as QSEHRAs and ICHRAs, are specifically structured to comply with the ACA. ICHRAs, on the other hand, must meet specific conditions set by the ACA, such as ensuring that employees have individual health insurance coverage that meets minimum essential coverage (MEC) standards.

HRAs can also assist employers in complying with the ACA’s employer mandate. This mandate stipulates that applicable large employers (ALEs) with 50 or more full-time equivalent employees are required to offer affordable health insurance that meets minimum value standards to full-time employees and their dependents. While traditional HRAs cannot be used alone to meet this requirement, integrating an HRA with a high-deductible health plan (HDHP) can help employers offer coverage that is both affordable and comprehensive.

The HRA can cover out-of-pocket expenses, making the HDHP more attractive and manageable for employees, meeting the ACA’s affordability and minimum value criteria.

No Pre-Funding Accounts

You do not need to pre-fund the HRA with a lump sum of money at the beginning of the plan year. Instead, you promise to reimburse employees up to a specified amount for eligible medical expenses as these expenses are incurred. This means you only pay out funds when an employee submits a claim and the claim is approved. This “pay-as-you-go” approach can help you manage cash flow more effectively since you are not required to set aside a large amount of money upfront.

This structure provides financial flexibility for employers, especially small businesses, as it avoids the need for significant initial outlays of cash. You can plan for and distribute your healthcare costs throughout the year rather than committing a large sum at once. This can be particularly beneficial in managing financial resources more efficiently and maintaining liquidity.

No pre-funding also reduces your financial risk. Since you only reimburse actual expenses incurred by employees, there is no risk of unused funds being tied up in pre-funded accounts. If employees do not use all of their allocated HRA funds within the plan year, you retain these funds, resulting in potential cost savings.

Competitive Benefits

In today’s job market, offering a robust benefits package is crucial for attracting highly skilled and talented employees. Prospective employees often look beyond salary when considering job offers and place significant value on comprehensive health benefits. An HRA allows you to offer a customized and flexible health benefits package tailored to meet your workforce’s diverse needs. This flexibility makes your company more attractive to potential hires looking for a supportive employer that prioritizes their health and well-being.

A well-implemented HRA can also improve employee retention by increasing job satisfaction and loyalty. Employees who feel their healthcare needs are adequately met are more likely to stay with their employer long-term. The financial support HRAs provide for medical expenses can alleviate stress by giving employees a sense of security knowing their healthcare costs are covered. This can boost employee satisfaction and lower turnover rates, saving your company money on recruitment and training.

Tax-Free Reimbursements For Employees

HRAs are meant to reimburse employees for qualified medical expenses, including a wide range of healthcare costs such as insurance premiums, deductibles, co-pays, prescription medications, and other out-of-pocket costs. As long as these costs are considered qualified under IRS rules, the reimbursements made through the HRA are not subject to federal income tax, Social Security, Medicare, or state income taxes in most cases.

The tax-free status of HRA reimbursements is a significant benefit for employees. When employees pay for qualified medical expenses out-of-pocket and then submit claims to the HRA, they receive reimbursements excluded from their taxable income. This means employees can receive financial assistance for healthcare costs without increasing their tax burden, effectively reducing their overall medical expenses.

Employer contributions to an HRA are also not counted as taxable income for employees. These contributions are considered part of the benefits package rather than direct compensation, allowing employees to benefit from additional financial support without the added tax implications. This structure makes HRAs an attractive option for both employers and employees, as it enhances the value of the benefits provided.

Factors Impacting HRA Tax Advantages

When considering the implementation of an HRA, it’s crucial to understand the various factors that can impact its tax advantages. Both you and your employees can benefit significantly from the tax-free nature of HRA reimbursements. However, several factors determine the extent of these benefits. These factors include:

• HRA type: The type of HRA offered significantly impacts the tax advantages available. For example, QSEHRAs and ICHRAs have specific tax benefits designed to comply with the ACA. These HRAs offer tax-free reimbursements for qualified medical expenses and premiums, while traditional HRAs may provide broader coverage but require careful structuring to maintain tax benefits.
• Employer and employee contributions: Employer contributions to HRAs are tax-deductible, providing a significant tax benefit. Since employees cannot contribute to HRAs, they receive tax-free reimbursements, enhancing their financial benefit. The level of employer contribution directly impacts the extent of these benefits; higher contributions can provide more significant tax savings for both the business and its employees.
• IRS regulations: Adherence to IRS regulations is critical for maintaining an HRA’s tax advantages. These regulations specify what constitutes qualified medical expenses, impose contribution limits, and set nondiscrimination rules. Noncompliance can result in penalties and the loss of tax-free status for reimbursements, directly impacting the tax benefits that employers and employees receive.
• Employee tax bracket: The tax advantages of HRA reimbursements can vary based on an employee’s tax bracket. Employees in higher tax brackets benefit more from the tax-free nature of HRA reimbursements because they avoid paying higher marginal tax rates on the reimbursed amounts. This makes HRAs particularly valuable for higher-income employees, as the relative tax savings are more significant.
• Tax reporting: Accurate tax reporting ensures that the tax benefits of HRAs are fully realized. Employers must keep detailed records of all contributions and reimbursements, and employees must provide proper documentation for their medical expenses. Proper tax reporting prevents issues with the IRS and maintains the tax-free status of HRA transactions, thereby preserving the intended tax benefits.
• State tax laws: State tax laws can influence the tax benefits of HRAs, as not all states follow federal tax treatment. Some states may have different rules regarding the taxability of HRA contributions and reimbursements. Understanding and complying with state-specific regulations are essential for ensuring both employers and employees receive the maximum possible tax benefits from their HRA.

Consulting with experts like J.R. Martin & Associates can significantly optimize the utilization of HRAs for your company and its employees. Our expertise ensures that the chosen HRA type aligns with your organization’s financial goals and meets employee healthcare needs while complying with IRS regulations and other legal requirements. This helps avoid costly penalties and maintains the plan’s tax-advantaged status.

By strategically setting reimbursement limits and managing cash flow, we can help your business control healthcare costs and provide substantial employee benefits.

Navigate Health Benefits With An Expert

Offering attractive employee benefits, such as HRAs, can significantly impact your business’s success and your employees’ financial future. With our help, you can determine which valuable perks to offer your employees while ensuring compliance with regulatory requirements. At J.R. Martin & Associates, we can assist in tax planning, annual reporting, plan amendments and updates, and record-keeping to help you shape your company’s legacy and secure a prosperous future for both yourself and your employees.