by Tony Novak, CPA, MBA, MT, last updated 9/14/2014
A simple and inexpensive way to save taxes under the Affordable Care Act.
Healthcare Reimbursement Arrangements (HRAs) often provide the best available framework for a small business that wants to health benefits to its employees for expenses that are not covered by primary major medical insurance. That need is expanded by the implementation of Obamacare. Today's insurance policies are designed to increase the range of medical costs that are covered but shift more of the cost of that treatment outside of the insurance policy. There are significant tax advantages to the business and the employees of covering such expenses through a HRA. This article provides a brief overview of HRA plans and the pros and cons of adapting a small business HRA.
To better understand the issue, it helps to consider the recent past and current state of a typical small business health plan. See if this scenario sounds familiar:
Prior to 2014: The business typically bought a group health insurance policy for its employees and paid part or all of the cost. This insurance typically paid most of an employee's health care costs. Group health insurance was an expensive employee benefit that was often not fully appreciated by the employees. The employees might have complained about the portion of the premium that they must contribute or the quality of the health plan and the service provided by the insurer. Since the plan was picked by the employer as a "one size fits all" decision, employees felt disengaged in their health plan. The cost of this plan rose by an average of more than 10% per year and this cost increase is expected to again this year. The cost is rising faster than any other business expense. Every year the business looks for alternate health insurance plans but with fewer health plans available it is increasingly more difficult to find a better deal. It is difficult to properly budget for future years, since health plan cost increases vary widely and are difficult to predict.
HRAs could be used to reimburse the cost of individual major medical insurance for employees not covered under a group health insurance plan. It was possible to select the best or lower cost insurance without regard to how that decision may affect taxes. (This is no longer the case under current tax regulations).
In 2014: Considering all the impact of small group health plans, the business is now considering cancelling the plan and allowing employees to buy their own health insurance through the individual insurance exchange. Some employees will qualify for a premium subsidy, others will not. There is still some confusion on the tax treatment of health plans and few providers of small business HRAs that meet the new IRS rules. Few employers made the switch from group insurance to individual insurance.
Businesses that reimburse the cost of individual major medical insurance no longer make that payment through the HRA but rather as a direct taxable reimbursement to the employee.
For 2015: Now consider this hypothetical solution for same small business that switches to a Special Purpose Health Reimbursement Arrangement1 for 2015. High renewal rate increases for small group insurance trigger more small firms to drop the coverage and send employees to the individual insurance exchange. But there is a down side; if the premium cost is paid by an employer, the individual insurance is no longer a tax-free benefit to the employee.
A Limited Purpose HRA can be used to recoup the tax cost lost in the insurance switch. This new type of HRA plan is designed to comply with current law by covering only employees who are enrolled in a qualified insurance plan and only covers medical expenses not paid through insurance. For most employees, this is more than half of our total health care costs. The ability to cover these out-of-pocket costs on a pre-tax basis can be more beneficial than covering the cost of insurance premiums. The HRA plan is typically designed to allocate a uniform maximum dollar amount of benefit each employee's health care expenses to supplement coverage under an insurance policy.
1) The maximum cost of the health plan is known in advance and controlled by the employer. Since HRAs are "as incurred" there is no need for the employer to pre-fund the plan. If medical expenses are lower than the maximum allowed under the plan, the employer realizes a savings (while in this case the employee still enjoys 100% coverage).
2) Employees fully appreciate the value of cash benefits that the employer provides directly to them more so than insurance benefits that must be claimed through a more scrutinizing claim process.
3) Employees may stay with their current group health insurance plan or select any other qualified health insurance plan that they like better. Some may now report that they can be covered under a spouse's plan (there is incentive to be covered by insurance but not necessarily the employer's health plan). Some may find better and less expensive health coverage purchased through an individual insurance exchange2.
4) Employees like the fact that they are in total control of their health care funds.
5) Independent professional help is available though the HRA plan adviser.3
6) A wider range of medical expenses may be covered by the HRA. No more mandatory out-of-pocket costs, co-pays or deductibles. The HRA may offers 100% coverage up to the plan limit of all medical, dental, eye care, preventative expenses and alternate health care.
7) There is no need to seek approval or referral from a health insurance company for these treatments covered y the HRA. Treatment may be obtained with any medical provider without the need to worry about a PPO list.
8) Unused benefits can be carried over to the next year, providing an incentive to be conservative as well as a built-in employment retention tool.
9) Executives and owners may be covered under the health insurance plan even if excluded from the HRA. (Additional health benefits are available to executives through benefit planning outside of the HRA).
10) Business budgeting is easier under an HRA than some other health plans; the employer simply decides the maximum cash benefits available to the plan.
This example scenario above is an oversimplification meant for the purpose of providing an overview of how HRA plans work. There are several potential disadvantages of a HRA plans that should be considered:
1) Some employees might not be able to afford the cost of major medical insurance if the policy is not entirely paid for by the employer. In this case, the employee may also be excluded from the HRA under new tax rules.
2) Some employees who buy their own individual health insurance might drop their health insurance. The employer may require that employees provide proof of qualifying health insurance as a condition of eligibility for HRA benefits. That additional administrative task may be a burden on small employers.
3) HRAs are subject to nondiscrimination rules and owner/employee limitations.
4) Owner/employees (other than C corporations) are treated the same as self-employed individuals in this regard and are not eligible for tax-free non-insured health benefits.
5) HRA plans should utilize a qualified independent claim administration in order to meet the requirements of a range of federal laws know as ERISA and HIPAA in addition to the IRS requirements for substantiation of claims. The cost of professional assistance should be calculated into the decision to adapt a HRA plan. Some small firms elect to handle this administrative task themselves so, in this case, the risk assumed by the business should be factored into the decision to offer the HRA.
6) Under current IRS regulations and DOL regulations, HRAs may no longer reimburse the cost of individual major medical insurance as was allowed in the past before ACA implementation effective in 2014. This is perceived as a negative by some who were accustomed to the more liberal tax treatment allowed to individual medical insurance.
Setup assistance for a small business HRA typically costs $150 at Freedom Benefits. Claims administration can cost more but the smallest companies tend to handle this on their own (often in direct opposition to the advice of their professional advisors).
1 Special Purpose HRAs are a new type of health benefit plan introduced with the implementation of the Affordable Care Act provisions for 2014 that are not used to pay for major medical insurance premiums but may be used to cover expenses not paid by major medical insurance. We should anticipate further clarification and regulations.
2 Coordination of benefits under a Special Purpose HRAs with individual health insurance is an untested area of practice. We should anticipate further clarification and regulations.
3 The author's firm Freedom Benefits provides small business plan adviser services under a packaged flat rate arrangement described on www.freedombenefits.org.
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