Employee Medical Reimbursement Arrangements

For those employers who would like to provide a medical plan for their employees, there are a number of options. Among those options are two infrequently discussed plans: Health Reimbursement Arrangements (HRA) and Flexible Spending Arrangements (FSA).

Each has its own distinct set of rules and requirements, which will be briefly discussed in this article. Before taking any action, an employer should obtain more in-depth information to determine how the plan will benefit his company and employees and be able to weigh the cost of the plan to the benefits it will provide.

Health Reimbursement Arrangements

A health reimbursement arrangement (HRA) is a type of employee benefit plan provided by an employer to reimburse eligible employees and their dependents for specified medical expenses not covered by other forms of insurance.

If all the requirements for this type of plan are met, then reimbursements of medical care expenses of a current or former (including retiree) employee and the employee's spouse and dependents generally are excludable from the employee's gross income. The medical expenses reimbursed by the plan may not be claimed as a medical deduction as part of itemized deductions on the employee’s Schedule A.

The general requirements for a health reimbursement arrangement (HRA) are that the employee benefit plan:

• Is funded solely by the employer and not through a salary reduction election or otherwise under a cafeteria plan;

• Reimburses the employee for medical care expenses incurred by the employee and the employee's spouse and dependents;

• Provides reimbursements up to a maximum stated dollar amount for a coverage period; and

• Carries forward any unused portion of the maximum dollar amount at the end of a coverage period to increase the maximum reimbursement amount in subsequent coverage periods.

These plans are allowed to reimburse employees for insurance premiums that cover medical care expenses including amounts paid for accident or health coverage premiums for current employees, retirees, and COBRA qualified beneficiaries. Reimbursable medical care expenses generally do not include expenses for qualified long-term care services.

Although owners who are sole proprietors, partners, or more-than-2% shareholders of an S corporation are themselves not eligible to participate in an HRA, an owner's spouse and children may participate if they are bona fide employees of the business.

An HRA may continue to make reimbursements to former employees or retired employees for medical care expenses after their employment has terminated or if they have retired (even if the employee does not elect COBRA continuation coverage). Thus, an HRA could, for example, provide that it will reimburse a former employee for medical care expenses (but only) up to an amount equal to the unused reimbursement amount remaining at retirement or other termination of employment. The HRA also could specify that the maximum reimbursement amount available after retirement or other termination of employment is reduced for any administrative costs of continuing such coverage. An HRA could, but is not required to, provide for an increase in the amount available for reimbursement of medical care expenses after the employee retires or otherwise terminates employment (regardless of whether the employee does not elect COBRA continuation coverage).

An HRA is a group health plan that generally is subject to the COBRA continuation coverage. However, an HRA would not be subject to the COBRA rules if the employer does not have at least 20 employees during an applicable measurement period.

Flexible Spending Arrangements

Flexible spending arrangements are employer-sponsored plans that permit employees to contribute pre-tax dollars to the plan, which, in turn, reimburses employees for qualified expenses. However, no contribution or benefit from an FSA may be carried over to any later plan year or period of coverage, other than in the case of certain orthodontia expenses reimbursed through a health FSA. Use it or lose it: unused benefits or contributions remaining at the end of the plan year (or at the end of a grace period, if applicable) are forfeited. Employees who itemize their deductions when filing their income tax returns may not claim a medical expense deduction for the medical expenses that were reimbursed from the health FSA.

There is no dollar limit on the amount that an employer may allow its employees to set aside under their individual health FSAs. However, an employer is free to set a limit, for each employee participating in the health FSA arrangement. Typically, employees will base their contribution on a conservative estimate of their medical needs for the year.

A health flexible spending arrangement may reimburse only “medical expenses” and therefore may not reimburse for other expenses such as dependent care expenses. A health plan that is a flexible spending arrangement must satisfy the following requirements to qualify for the exclusion from income:

(1) Meet the medical coverage and reimbursement exclusion requirements.
(2) The maximum amount of coverage must be available at all times throughout the year.
(3) The coverage period must not be less than 12 months except in the case of a short year. In addition, there is a 2½ month grace period for qualified expenses that occurred within the coverage period to be paid.
(4) Prohibit the reimbursement of expenses other than medical expenses.
(5) Provide that the payment schedule for required employee premiums not be based on the rate or amount of covered claims.
(6) Require that adequate written substantiation be given before reimbursement is made.
(7) Restrict reimbursements to medical expenses incurred during the period of coverage.
(8) Not allocate forfeitures among premium payers based on their individual claims experiences.

In addition, FSA plans can be set up to cover dependent care and adoption expenses. Neither is discussed in this article, but you can call our office for more information.

The following are the major differences between Flexible Health Spending Accounts (FSA) and Health Reimbursement Accounts (HRA):

	FSA	HRA
Excess Funds	Forfeited	Carried Over
Plan Funding	Employee (1)	Employer
Participation	Any Employee	No Self-Employed (2)

(1) Employers may opt (are not required) to also make nondiscriminatory contributions to the plan on behalf the employees.

(2) Owners who are sole proprietors, partners, or more-than-2% shareholders of an S corporation are themselves not eligible to participate in an HRA.

These plans are normally administered by commercial firms who act as plan administrators, have pre-approved plans, monitor your plan for compliance and perform other required functions. Please call for additional information.

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