How to establish separate employee bank accounts in a small business HRA plan

by Tony Novak, CPA, MBA, MT, revised 10/21/2014

Tax Update: Beginning in 2014 HRAs can only be used to supplement coverage for employees who are covered under a primary employer-provided health plan (usually a qualified group health insurance plan).

Summary: Small businesses who administer their own Health Reimbursement Arrangement (HRA) plans should avoid using separate bank accounts for each employee if possible but we know that some firms insist on this approach. When this practice of using separate accounts is used then the employer should follow these steps to set up the accounts to ensure that the accounts are owned by the employer and are not treated as tax deductible transactions at the time that segregated accounts are funded.

A Health Reimbursement Arrangement (HRA) is frequently the most efficient way for an employer to provide funds for routine health benefits to employees¹. An HRA is a tax-qualified employee benefit plan acknowledged by the IRS and used by virtually all of the nation' s largest employers. Over the past two years smaller firms have adapted HRA plans but usually require that the plans operate at less than half of the cost per employee of the comparable health plans of the larger firms. Cutting costs means cutting health benefits and reducing overhead expenses for the administration of the HRA plan. Fortunately there are ways to operate a cost-efficient HRA plan either with or without using separate employee bank accounts.

Small business owners may be tempted to adapt these new health plan designs to lower costs and enjoy the other benefits without proper regard for the applicable laws that govern these health plans. As with any tax-qualified employee benefit plan, sloppy set-up or administration can result in undesired tax consequences. A professional adviser' s objective, in this case, is to provide a high quality but low cost benefit support service that meets all applicable requirements, specifically the IRS procedural requirements for HRA plans that use debit cards and the health information handling administrative procedures now integrated with the implementation of federal HIPAA law.

Freedom Benefits provides consulting services to small businesses through www.FreedomBenefits.org, a provider of low cost employee benefit plans. All Freedom Benefit HRA plans are self-administered. This means that the employer retains full responsibility for the legal operation of the benefit plan even though some functions and services may be provided by others. In this case certain key functions are handled by the Plan Adviser including help with planning, design, documentation, employee communication, claim verification and general advisory assistance to the business and its employees.

Before discussing the separate bank account setup, it makes sense to consider the way that traditional HRA plans function without separate bank accounts. Most employers pay HRA plan expenses from the same bank account as their other business expenses. HRA checks are handled in much the same manner as an employee' s request for travel expense reimbursement. The key difference is that the HRA claim accounting is handled by an independent third party (the Plan Adviser) rather than directly by the employer' s internal bookkeeper. In most HRA plans the employer issues a check to each eligible employee after receiving a claim report is received from the Plan Adviser. The only disadvantage of this traditional method is the gap in time that passes between the incurrence of the medical expense and the date of reimbursement. Most small businesses issue HRA reimbursement checks on a quarterly basis, but any other schedule (daily, monthly, annually) is permitted.

An increasing number of small business employees now request separate bank accounts for their HRA funds. This option is possible in the HRA plan design, but creates additional work and possible confusion during the set-up process. Banks are generally not able to provide advice with the set-up and operation of self-administered HRA plans. Some banks that sell HRA services may only be familiar with other types of HRA plans might take a contradictory position saying that this feature is not possible in your small business HRA. Of course, we may not oppose the decision of a bank that declines to open any customer account for any reason.

Freedom Benefits does not recommend using separate bank accounts for each employee in a self-administered HRA plan, yet this is understandably a popular request from employees². It is usually better to either use your existing business bank account (and bypass the separate account option) or hire a third party administrator to provide this service. If you must have separate employee accounts in a small business HRA plan and are not willing to hire a third party administrator to handle this task, the following instructions show how to accomplish this set-up option.

 

Five Steps to Establish Separate Employee Bank Accounts in a Small Business HRA

Step One

Try to use the same bank as the business checking accounts to save time over the long run, especially if you use an online banking service within the business accounting system. Inquire about the fees for the account. Consider the fees for accounts with small balances, as well as fees for checks and overdraft charges.

Step Two

Complete a number of checking account applications (one for each employee). Complete the account application in the same manner as the primary checking account. The account name is the business name. The address is the business address. The tax ID number is the business tax ID number.

There are two differences between the HRA accounts and the regular business checking account with these two exceptions: 1) on the second title line below the business name include some additional identifying information. For example, "for John Smith" would indicate that this bank account is intended for use by the employee named John Smith. This does not mean that John Smith owns the account. It is important to note that the "for John Smith" is used as an account identifier, not as an indication of the account owner' s name or the existence of a trust account.   If the bank object to the usage of an employee' s name on the account as an identifier, then use a different designation such as an internal account number. For example, if your accounting software assigns account number "77034" to the health plan expenses of your employee John Smith, then your could open the bank account under the name "Acme Business Services Account 77034".

It is important that the account be set up under the business name and tax ID number. Accounts owned by the employee are not part of a tax-qualified HRA plan.

If checks or debit cards (or both) are desired, then indicate this on the account application. List the employee as the second authorized user/signor on the account. Request and record a separate PIN for each employee account.

An employer should never imply that the money in an HRA account belongs to an employee or that the employee has any right to receive this money other than through a benefit claim as written HRA plan document.

Step Three

Make an initial deposit in each account. Deposits may be made at the discretion of the employer with regard to amount and timing but should be in accordance with the benefit plan documents².  It might be desirable, for example, to open each account with a nominal $25 deposit and then electronically transfer the balance of the accrued benefit into the account at a later date that is indicated in the plan description. For example, the plan document might say that claims may be reimbursed not later than 30 days after the end of the period. In some cases the accounts might be funded in advance. No business tax deduction is recorded at the time the accounts are funded nor does this funding transaction result in any payroll transaction. The transaction should be recorded as a funds transfer from one business bank account to another, without any tax consequences.

Step Four

Distribute the debit card and checks to each employee for the account that lists her name. Make sure to also distribute the account PIN so that employees can check the account balance. Most banks allow the account balances and activity to be checked in a branch, by telephone or online. Make certain that employees understand that these accounts are owned by the business assets and are not the assets of  individual employees. This article does not cover HRA claims administration that should be handled separately by an administrator not affiliated with the employer.

Step Five

Keep up to date with opening new accounts for subsequently hired employees and close the accounts of terminated employees. (It is best to close the account as soon as a decision to terminate employment is made and then make the final HRA disbursements with a regular employer check). Balances left in an employee' s account after termination of employment belong to the employer. If this amount is disbursed to the employee then regular wage taxes are payable on the amount.

Other than the specific additional steps listed here, nothing else changes with the HRA plan. Claim submission and validation is handled independently of the bank account transactions. Claims are still submitted online or through other methods allowed in the plan document. The process is unaffected by the use of the bank accounts except that a reconciliation of balances on the claim report vs. the bank statements is included on the claim validation report.

Some small business HRA plans have used this procedure effectively without any further concern. Others may be using this procedure and be unaware of potential tax liabilities that may arise in the event of a tax audit. It is legal and complies with all applicable regulations. Employer should be aware that in the event of a tax audit, the tax examiner might conclude that unaccounted withdrawals from the HRA account are taxable wages and that access additional wage taxes and penalties are due. Companies that are required to produce audited financial statements should consult with their CPA
to determine the HRA plan reporting under Generally Accepted Accounting Procedures. In some cases it may be necessary to create an additional accounting entry for accrued contingent wage taxes attributable to HRA fund balances³.

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Footnotes:

¹ "Twenty-Five Reasons Small Businesses Choose HRA Plans". HRAs are useful for common law employees only and are not effective for self-employed individuals, partners, LLC members or shareholder employees of Subchapter S corporations.

²The reasons to avoid separate accounts are: 1) this practice defeats the possibility that the employer will benefit from favorable claims experience (healthy employees), 2) increases the possibility of non-qualified taxable withdrawals with resulting wage tax liability, 3) increased accounting cost, 4) creates the false impression that HRA funds belong to the employee or are tax deductible at the time of contribution, 5) increased bank fees. The primary reasons employees want this feature re: 1) no paperwork to access cash, 2) faster access to cash, 3) increased possibility of taking non-qualified withdrawals, especially at termination of employment. The reason Freedom Benefits does not recommend this option it is that it raises costs and risks to the business while producing little real dollar value for the employees.  See "Solving Accounting Problems of Small Business HRAs" for more information.

³ If it is unlikely that the employer will fund the accounts in accordance with the plan documents, then the plan documents should be amended as soon as possible.

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