Imagine that you are a mechanic and someone walks into your shop and asks you to put wings on his Honda Civic. You might say, “That’s silly, Civic’s don’t fly” and dismiss the request. Then three more owners walk in with the same question. You think about it some more and say “Well, it might look cool even if it can’t fly; let’s try it”. Then after a few dozen such requests, you assemble a Decorative Civic Wing Mounting Kit that your shop sells to the public. Then one day you get a visit from the Federal Aviation Administration saying that they are investigating a complaint about a Civic stuck on an airport runway that could not take off because the wing mount failed.
Such is the case of my work with Health Reimbursement Arrangements (HRA). I’ve written dozens of articles and produced free resources that have been used and apparently sometimes misused by businesses for about two decades. Then in 2014 federal tax law changed as a result of the Affordable Care Act. Most HRAs are now obsolete and have little practical value in small business planning today. Now the tax problems are coming out of the woodwork as businesses plan to terminate their HRAs. The tax problems we are finding now are not the result of the 2014 changes but are due to mistakes and misinterpretations made well prior to 2014. They don’t have a 2014 tax planning issue but rather a prior year reporting error.
Over the past week I’ve heard from 4 widely different businesses with improperly designed HRAs. All four have prior year tax liabilities as a result of the HRA errors. It is not clear how they will resolve the problems and I am not the accountant for any of these firms. The latest one specifically pointed to an article I wrote as the source of his misinformation. The passage quoted as the source of his misunderstanding was taken out of context and he apparently ignored the bold type and underscored cautionary portions also included in the same article that would have easily helped him avoid the tax reporting error.
The specific tax issues that came up in this week’s communications required these clarifications:
1) HRAs can not be used to put away tax-free money for some future health care expenses. (HSAs can be used for this purpose).
2) HRAs can not accept employee contributions or be funded with salary reductions. (FSAs can be used for this purpose).
3) HRAs can not be used in a small LLC where the only employees are a husband and wife.
4) HRAs are usually not useful for small business owners or partners.
5) Beginning January 2014, HRAs can not be used for small business employees who are not covered by the employer’s primary health insurance.
I feel bad that some of my published tax advice was misinterpreted. I admit that part of the reason that I write specific articles it to capitalize on public demand for information on a specific issue. Yet public demand does not always translate into common sense. If a bunch of people ask the same specific question “How do I …” then I’ve been inclined to publish an advisory article on that same tax topic, regardless of whether it makes much sense in the larger scale or context. Going forward, I’m more likely to avoid answering some types of tax question like, for example, “How do I get receipts for my $1 donations to street corner charity collections?”. It’s not that there is anything wrong with answering the question but rather any answer would give undue credibility to some unstated presumption that it is advisable or required to get receipts for small donations. In order to avoid the problem of someone saying “You said I needed receipts to take deductions for $1 charitable donations”, it might be better to not give the advice at all in that context.
In any event, I am available to help with voluntary compliance measures for businesses that have improperly reported HRA transactions. It is always better to take these corrective measures voluntarily rather than wait for an audit. Improper HRA tax treatment is easily detected in any examination of small business records and the potential penalties can be especially severe because the taxes in question represent an under-reporting of wages taxes – something the IRS takes very seriously.