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Labor Law for All Employers

Howard L. Steele Jr.

HRA - Health Reimbursement Account

An HRA is a tax-exempt fund established by an employer for an employee that can be funded only by employer contributions, and not through a Section 125 cafeteria plan. The contributions to the fund are excludable from the employee's gross income, and are not subject to FICA or FUTA taxes, and the disbursements from the fund to pay for qualifying medical expenses are also excludable from the employee's gross income. The assets in the fund can be used only to pay the medical expenses of the employee, the employee's spouse, and the employee's dependents. To the extent amounts remain in the fund after an employee dies, the fund can be used to pay the medical expenses of a deceased employee's former spouse and dependents.

Internal Revenue Service Notice 2002-45 governs Health Reimbursement Accounts (HRAs). It defines an HRA as "an arrangement that:

  1. is paid solely by the employer and not provided pursuant to salary reduction election or otherwise under a Section 125 cafeteria plan;
  2. reimburses the employee for medical care expenses (as defined by Section 213(d) of the Internal Revenue Code) incurred by the employee and the employee's spouse and dependents (as defined in Section 152); and
  3. provides reimbursements up to a maximum dollar amount for a coverage period and any unused portion of the maximum dollar amount for a coverage period is carried forward to increase the maximum reimbursement amount in subsequent coverage periods."

As explained, in Revenue Ruling 2002-41, as an employer provided health plan, amounts contributed by the employer to an HRA are generally excludable from an employee's gross income under Code Section 106(a) and medical reimbursements paid out of an HRA are generally excludable from an employee's gross income under Code Section 105(b). In order for the reimbursements to be excludable from the gross income of a highly compensated employee, the HRA must meet the nondiscrimination requirements of Code Section 105(h).

IRS Notice 2002-45 requires that each medical care expense under a HRA must be substantiated. An HRA cannot reimburse a medical expense that was deducted for federal income tax purposes in a prior taxable year, and it cannot reimburse an expense that is incurred before the date the HRA goes into existence or before the employee is first enrolled in the HRA.

An HRA is a group health plan subject to COBRA continuation requirements. It meets these requirements by proving for the continuation of the maximum reimbursement amount for an individual at the time of the qualifying event and by increasing that maximum amount at the same time and by the same increment that it is increased for similarly situated non-COBRA beneficiaries (and by decreasing it for claims reimbursed). If the other COBRA requirements relating to premiums are met, the COBRA premium requirements are met if the premium charged is the same regardless of the maximum reimbursement amount remaining for the COBRA beneficiary at the time of the qualifying event.

An HRA is ordinarily an employee welfare benefit plan under ERISA necessitating that ERISA reporting and disclosure rules are met. ERISA fiduciary duty rules may also apply to an HRA that is funded. Also, HIPAA privacy requirements apply to HRAs as they do to Section 125 Cafeteria Plan Health FSAs. Employer deduction limits under Code Sections 419 and 419A may also apply to an HRA that is funded and does not qualify for an exception to those limitations. Code Section 404(a)(5) and (b) employer deduction rules apply to an HRA that is not funded to generally make the deduction available at the time amounts are actually reimbursed to employees. If an HRA is funded Section 404(a)(5) requires that separate accounts be maintained for each employee for the employer to deduct the contributions when employees would have been taxed on the contributions if the amounts were not expressly excludable from compensation by Code Sections 106(a) and 105(b).

Resolves Use-It-Or-Lose-It Dilemma

The advantage of an HRA to an employee is that since an employee has no election between excludable benefits and cash, it is not a cafeteria plan. Accordingly, it is not subject to the use-it-or-lost-it requirements of Code Section 125. However, it is less flexible than a cafeteria plan since health care benefits are the only excludable benefits that an HRA can provide.

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