Summary: Closely held small businesses with middle-income employees may use a HRA to cover out-of-pocket medical costs as one of the easiest ways to cut 2018 taxes at minimal administrative and setup cost. (This is not a strategy for sole proprietors or partners).
The brand new federal tax law increases the incentive for middle-income workers to look for alternate ways to cut their federal income taxes beginning in January 2018.
Taxpayers in the $60,000 to $80,000 income range generally received the smallest tax cuts and some cases will see a tax increase. One of the most obvious effective tax-reducing strategies is to move some expenses that were paid with after-tax earnings and move them to an employer-paid employee benefit plan that escapes wage taxes. One way is through an employer-sponsored Health Reimbursement Arrangement or HRA. The effect is that money paid through an HRA avoids tax. A $5,000 expense subject to total wage taxes of about $1,500 that can be avoided through this strategy. This benefit works for employees only, sole proprietors and partners ar excluded.
While each small business benefit plan has its own rules and limitations, this blog post attempts to summarize the three basis steps required to run a successful small business Health Reimbursement Arrangement.
Step 1 Design and Document – Employers are mostly free to design employee benefit plans to their liking, and IRS gives much latitude for doing so. Requirements for an HRA are listed here. Firms like mine that provide small business employee benefit support generally keep a library of plan designs available for a wide range of employers. In almost all cases an employee benefit plan should be documented in writing both as an IRS requirement and a good business practice.
Step 2 Account for the Expenses – As employees incur health care expenses that can be reimbursed on a tax-free basis, it is important to have an efficient system to manage the required record keeping for what is called an “accountable plan” with maximum tax benefits and minimal risk of adjustment upon audit. I typically recommend a cell-phone based app that is integrated with the employer’s accounting system. The expense reimbursement reports are typically reviewed and approved by a manager or accountant before submission for reimbursement.
Step 3 Reimburse through Payroll – The easiest way to make tax-free reimbursements is through the payroll system. This is easy to set up and requires minimal extra effort and usually no other cost.
The key to success in a small business health plan is to have one person who is familiar with the entire plan from the design through the payroll settlement function. This allows for fast and efficient resolution of any issue that might arise, whether with the employer or an individual employee.
HRAs are often added as a low-cost or free add-on to insurance or payroll services. $5,000 of expenses run through an HRA will typically save $1,500 er year in wage taxes/
I am pleased to discuss the options that may work best from your business.