Reduce Income Tax and Self-Employment Tax with a Health Reimbursement Arrangement (HRA)
A health reimbursement arrangement (HRA) is solely funded by an employer for the benefit of its employees. Employees are reimbursed by the employer tax free for qualified medical expenses up to a maximum dollar amount for a coverage period.
Qualified medical expenses are those specified in the plan that would generally qualify for the medical and dental expense deduction on Form 1040, Schedule A. Qualified medical expenses include amounts paid for health insurance premiums, amounts paid for long-term care coverage, and deductible/copays that are not otherwise covered by a health insurance plan.
Sole Proprietor with Employee Spouse Strategy
Example: John is a sole proprietor with this wife, Marsha, as his only employee. John provides his one employee an HRA that will reimburse up to $9,000 of medical expenses per year. Marsha uses the $9,000 to pay for health insurance premiums for a policy that she purchases, plus deductibles and copays not covered by her insurance policy. Marsha purchases a family policy that also covers John as her spouse. Thus, the $9,000 is 100% deductible by John as a business expense on Schedule C and 100% excludable by Marsha as an employee benefit.
Market Reform Rules
All employee group health plans are subject to the Market Reform rules under the Health Care Reform Act of 2010. HRAs are generally considered to be group health plans and thus subject to the Market Reform rules. However, the Market Reform rules do not apply to a plan that has only one participant who is a current employee on the first day of the plan year. Also, the Market Reform rules do not apply to plans in relation to a provision of reimbursing only excepted benefits, such as accident-only coverage, disability income, certain limited-scope dental and vision benefits, certain long-term care benefits, and certain health FSAs [IRS Notice 2013-54].
Since Marsha is John’s only employee, the Market Reform rules do not apply to John’s HRA plan. If John were to hire more employees, John would need to purchase health insurance for each employee and integrate his HRA with other coverage in order for his HRA to meet the Market Reform rules.
Under the Health Plan Reform Act of 2010, there is established a new Patient-Centered Outcomes Research Trust Fund (PCORTF) designed to carry out provisions relating to comparative effectiveness research. This trust fund is funded by a fee imposed on specified health insurance providers. The fee for plan years ending on or after October 1, 2014 and before October 1, 2015, is $2.08 multiplied by the average number of lives covered under the health plan. The fee is paid as an excise tax by filing Form 720, Quarterly Federal Excise Tax Return, for the quarter covering April, May, and June with a due date of July 31.
In my example above, with John and Marsha, John must pay the excise tax of $2.08 for his one employee (Marsha) covered under his HRA by filing the second quarter Form 720 by July 31 each year.
Retain a competent adviser in benefits administration to assist you in properly setting up your plan and to monitor its compliance. Also, discuss this strategy with your professional tax consultant before you implement it.