Health Reimbursement Arrangements (HRAs) are health care plans paid for by an employer to reimburse the medical expenses of its employees, their spouses, and dependents. HRAs are designed to provide more patient-directed features, that give employees more choice and greater control over their health care coverage (consumer-driven, or consumer-directed health care). Most commonly, the employer would purchase basic health insurance coverage for its employees, usually with a high deductible. Then the employer would set up an account (the HRA) that the employees can draw upon to pay routine medical bills, and medical expenses not covered by the high-deductible policy.
HRAs are funded solely by the employer, and cannot be funded through employee salary deductions. Also, HRAs are generally not subject to the same plan design requirements that apply for an Flexible Spending Arrangement offered as part of a cafeteria employee benefit plan. The employer sets the parameters for the HRA, and HRAs remain with the originating employer – they do not follow the employee to new employment.
HRAs as Compared to Other Tax-Favored Health Care Plans
HRAs have aspects that make them different from other tax-favored health plans such as Health Savings Accounts (HSAs), Medical Savings Accounts (MSAs), and Flexible Spending Arrangements (FSAs). For example, under a Health Reimbursement Arrangement, an unused balance can be carried over to the following year, so the “use it or lose it” aspect of a Flexible Spending Arrangement does not apply. An HRA provides reimbursement up to a maximum dollar amount for a coverage period, and any unused portion of that maximum amount is carried forward to increase the maximum reimbursement amount in subsequent coverage periods. And a HRA can also reimburse employees for medical insurance, which is not the case under an FSA. The reimbursement of medical insurance costs includes current employees, retirees, and COBRA qualified beneficiaries.
Also, according to guidance from the U.S. Treasury Department and the Internal Revenue Service (IRS), HRAs can allow former employees, including retirees, to continue to have access to unused reimbursements. HRAs can have a provision that medical expenses are first reimbursed by a Flexible Spending Arrangement, and that HRAs are considered group health plans and are subject to continuation of coverage under the COBRA requirements.
Under a Flexible Spending Arrangement, the maximum amount of reimbursement must be available at all times during the coverage period. This is not the case with a Health Reimbursement Arrangement. And, there is no mandatory 12-month coverage period for an HRA. Also, the requirement that reimbursed expenses must have been incurred during the coverage period does not apply to HRAs. A medical expense incurred in one period can be reimbursed in a subsequent period, provided the person was covered under the HRA when the claim occurred. But a medical expense incurred before the HRA was in existence, or before the employee was enrolled in the HRA, cannot be reimbursed.
Taxability of HRAs
Medical benefits paid by Health Reimbursement Arrangements that meet certain requirements are not taxable to the employees. The basic requirements are that the arrangement must be funded solely by the employer, as mentioned above, and only substantiated medical expenses can be reimbursed. An HRA does not qualify for exclusion of benefits from income tax if an employee has the option of receiving cash or some other taxable or non-taxable benefit other than the reimbursement of medical care expenses.
If any other type of payments or benefits are provided, all the payments from the arrangement, including medical reimbursements, would become taxable. For example, if an HRA pays a death benefit without regard to medical expenses, none of the amounts paid under the arrangement would be considered medical expense reimbursements exempt from tax. If an employee receives a bonus, or severance pay related to the maximum reimbursement amount remaining in an HRA upon retirement or termination of employment, none of the benefits from the HRA would qualify for tax exclusion.
Qualified medical expenses are those specified in the HRA plan, and are generally those that would qualify for the itemized deduction for medical and dental expenses on Schedule A of Form 1040. But if you are reimbursed by the HRA, you cannot claim an itemized deduction for the same expenses.
Coverage Under an HRA
Current employees, former employees including retirees, their spouses and dependents, and the spouses and dependents of deceased employees, can be covered under an HRA. Former employees and retirees can continue to receive medical reimbursements under an HRA even if they do not elect COBRA coverage. The HRA can have a provision allowing former employees or retirees to be reimbursed only up to the unused reimbursement amount remaining at the time of retirement or termination, and the HRA can also stipulate that reimbursements after retirement or termination are reduced by the administrative costs of continuing the coverage.
Self-employed individuals are not eligible to participate in a Health Reimbursement Arrangement.
Cafeteria Plans
Employer contributions to an HRA cannot be attributable to a salary reduction plan, such as an FSA. But the fact that an HRA is provided in conjunction with a cafeteria plan will not make it a salary reduction plan. An HRA can be provided as part of a cafeteria plan and still qualify for tax exemption of medical expense reimbursements. An employer can offer employees a choice between an HRA and coverage under a Health Maintenance Organization (HMO), and the HRA benefits would still be excluded from tax, provided the employees do not have the option of receiving cash or other taxable benefits.
But, if the medical expense reimbursement arrangement interacts with other cafeteria plans in such a way that employees can use salary deductions to indirectly fund the arrangement, then that arrangement would not qualify for exemption from tax as an HRA.
If there is a correlation between the maximum reimbursable amount under the medical expense reimbursement arrangement, and the salary reduction that can be elected for the other health care coverage, then the reimbursement arrangement would not qualify as an HRA. And, if employees can choose to use the medical expense reimbursement arrangement to pay for the premium for other health insurance coverage, rather than using a salary reduction, the reimbursement arrangement is being used to indirectly fund the health insurance coverage and would not qualify as an HRA.
Ordering Rules
If a medical expense is covered under both a Health Reimbursement Arrangement and a Flexible Spending Arrangement, amounts available under the HRA must be used up before reimbursement can be made from the FSA. But this rule is not violated if a medical expense not reimbursable under an HRA is paid from an FSA.
Reference:
Aetna – Health Reimbursement Arrangements: www.aetna.com Galen Institute – Health Reimbursement Arrangements: www.galen.org Internal Revenue Service Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans: www.irs.gov National Association of Health Underwriters – Health Reimbursement Arrangements: www.nahu.orgU.S. Department of the Treasury – Press Room – Office of Public Affairs – Treasury and IRS Issue Guidance on Health Reimbursement: www.urtreas.gov
