A Health Reimbursement Arrangement account, or HRA, is an employer-funded health plan that is used by an owner to reimburse employees for medical expenses not covered through their standard healthcare insurance plan.
With an HRA, the business owner funds the plan by making the distributions. These distributions are tax-deductible for the business. Although business owners can participate in the plan for tracking purposes, unless their business is a C-corporation, the reimbursements are not tax-free.
An HRA may be used to reimburse employees for certain qualified out-of-pocket medical expenses such as co-payments, deductibles, and employee’s health insurance premiums. HRAs are also used as a small business alternative to group health insurance.
Can a Small Business Employer Also Participate in an HRA?
With the costs of health insurance coverage rising significantly over the last decade, far more businesses now offer HRAs along with high-deductible health plans (HDHPs). In some ways, HRAs offer advantages over the more common Health Savings Account (HSA) that are typically used in conjunction with HDHPs.
For small business owners who are considering adding an HRA, a reasonable question might be whether, as business owners, they can participate in the HRA?
The short answer is: It depends.
Determining whether an owner can participate in the company’s HRA depends on several factors, including the company’s business structure and the percentage of the business ownership held by each working owner.
More to the point, the tax-free benefits under an HRA can be provided only to:
- Covered tax dependents, and
- Children who haven’t attained age 27 by the end of the tax year.
- Current and former employees (including retirees), and their spouses.
Owners who are “self-employed individuals” as defined by the Internal Revenue Code Section (IRC) 401(c) are not considered employees for this purpose and, consequently cannot participate in an HRA on a tax-favored basis.
In fact, determining who is and is not eligible for “tax-favored HRA participation” is somewhat complicated.
According to an article at JCCS.com,
“Generally, a self-employed individual is someone who has net earnings from self-employment as defined in IRC Sec. 1402(a), accounting for only earnings from a trade or business in which the ‘personal services of the taxpayer are a material income-producing factor.’ Ineligible owners include partners, sole proprietors and more-than-2% shareholders in an S corporation. Stock ownership by employees of a C corporation doesn’t preclude their tax-favored HRA participation.”
The restrictions regarding HRA participation extend to others as well as employers.
“The ownership attribution rules in IRC Sec. 318 apply when determining who’s a more-than-2% shareholder of an S corporation, so any employee who’s the spouse, child, parent or grandparent of a more-than-2% shareholder of an S corporation would also be unable to participate in the S corporation’s HRA on a tax-favored basis. A disqualified individual (whether because of direct or attributed ownership) could, however, be the beneficiary of a qualifying participant’s HRA coverage if he or she is the qualifying participant’s spouse, tax dependent or child under age 27.”
HRAs or HSAs
Although self-employed individuals cannot receive tax-free HSA contributions through cafeteria plans – those plans that allow employees to choose from different benefit options made before taxes are deducted – they can use HSAs.
This benefit is why many employers tend to favor HSA programs over HRAs. However, there are advantages with HRAs for employers:
- More control over how amounts are spent
- Lower costs relative to the nominal amount of benefits provided
- Only need to be funded when participants incur expenses (unlike HSAs)
Similar to HRAs, an HSA for employers (or self-employed business owners) comes with restrictions and requirements.
An article from Bend Financial sums it up this way,
“Since an HSA isn’t a type of insurance, it comes down to you as a self-employed individual needing to have an HSA-compatible health plan. According to HSA rules set by the IRS, you can only open an HSA if you’re covered by an HSA-eligible high-deductible health plan (HDHP). So if you’re a self-employed individual covered under a qualified plan, you may open and contribute to an HSA.”
Helping Local Small Business Owners Navigate Health Insurance
California Group Health Insurance is a great way to keep and reward valued employees by providing medical protection for them and their families. J.C. Lewis Insurance Services offers a variety of affordable and flexible options allowing companies to choose portfolios and contribution options suited to their specific needs.
We are a family-owned and operated California health insurance agent licensed to do business in California, and we specialize in medical insurance plans for small businesses, as well as for individuals and families, and people with Medicare.
At J.C. Lewis Insurance Services, we can tailor our recommendations to your particular needs since we are licensed with most major carriers in California. You save time and money, and we can quickly define your particular needs and recommend the best products and prices to meet those needs.
FAQs on Health Reimbursement Arrangement (HRA) Accounts
1. What is a Health Reimbursement Arrangement (HRA)?
An HRA is an employer-funded health plan that reimburses employees for out-of-pocket medical expenses not covered by their primary health insurance. These expenses can include co-payments, deductibles, and even health insurance premiums. The funds allocated by the employer are tax-deductible, offering a financial benefit to the business.
2. Can small business owners participate in their own HRAs?
The ability for a small business owner to participate in an HRA depends on the business structure. Generally, owners of sole proprietorships, partnerships, and S-corporations (with more than 2% ownership) cannot participate on a tax-free basis. However, owners of C-corporations can participate and receive tax-free reimbursements.
3. How do HRAs benefit small businesses financially?
HRAs can significantly reduce healthcare costs for small businesses. They provide a tax-advantaged way to cover employees’ medical expenses without the upfront costs of traditional health insurance. Since HRAs are only funded when expenses are incurred, businesses save money by avoiding unnecessary payments.
4. What types of expenses can be reimbursed through an HRA?
HRAs can cover a variety of medical expenses, including co-pays, deductibles, prescription medications, and health insurance premiums. This flexibility helps employees manage their healthcare costs more effectively and ensures they are not burdened by unexpected medical bills.
5. How do HRAs compare to HSAs?
While both HRAs and HSAs offer tax advantages, they serve different purposes. HRAs are funded solely by employers and reimburse employees for qualified medical expenses. HSAs, on the other hand, can be funded by both employers and employees, and the funds can be invested for future growth. However, HSAs require a high-deductible health plan (HDHP).
6. What are the tax implications of an HRA for employers?
Employers can deduct the contributions made to HRAs from their taxable income, reducing their overall tax burden. This makes HRAs a cost-effective way to provide health benefits to employees while enjoying tax savings.
7. Are there any limitations on who can benefit from an HRA?
Yes, there are limitations. Besides the restrictions on self-employed individuals and S-corporation owners with more than 2% ownership, HRAs can only provide tax-free benefits to employees, their spouses, tax dependents, and children under 27. These restrictions ensure that the HRA benefits are targeted toward those who need them most.
8. How does an HRA improve employee satisfaction and retention?
Offering an HRA can greatly enhance employee satisfaction by reducing their out-of-pocket healthcare costs. This benefit can be a key factor in retaining employees, as it demonstrates the employer’s commitment to their well-being. Additionally, HRAs can make a company more attractive to potential hires.
9. What steps are involved in setting up an HRA?
Setting up an HRA involves several steps:
- Determine the budget for the HRA.
- Decide which expenses will be eligible for reimbursement.
- Establish the plan documentation, outlining the details of the HRA.
- Communicate the plan to employees and provide them with the necessary forms and instructions for claiming reimbursements.
- Regularly review and adjust the plan as needed to ensure it meets the needs of both the business and its employees.
10. Why should small businesses consider offering an HRA over traditional health insurance?
HRAs offer more flexibility and control over healthcare spending compared to traditional health insurance. Small businesses can tailor the HRA to meet their budget and employees’ needs. Additionally, HRAs reduce the financial risk associated with providing health benefits, as funds are only disbursed when claims are made. This makes HRAs a more sustainable and cost-effective option for many small businesses.