What types of HRAs should a small business owner consider offering his employees?
Question of the week: What are the pros and cons of the different HRAs available to a small business owner with three employees?
Q: What types of health reimbursement arrangements (HRAs) might be suitable for a small employer with three employees?
My client Chris recently hired three employees (two full-time and one part-time) to assist with his expanding wine distribution business. Chris has health insurance coverage through the marketplace. His business is an LLC, filing taxes as a sole proprietorship on Schedule C. He isn’t sure what type of health insurance his three employees have (one of them may have a marketplace plan, too) and would like to offer them some assistance. He has heard about health reimbursement arrangements (HRAs) that let him help pay for some of his employees’ insurance premiums. What type of HRAs should Chris consider for his business? Can he use an HRA to pay for his own health insurance?
A: The employer could consider a qualified small employer health reimbursement arrangement (QSEHRA) or an individual coverage health reimbursement arrangement (ICHRA). Both types help pay for employees' health insurance and both have advantages and limitations.
An HRA is one option for an employer to help out with employees’ medical expenses. However, Chris is not an employee and may not reimburse his own medical expenses or premiums from an HRA.
There are several different types of HRAs that may be used to pay for qualifying medical expenses. Only some types of HRAs may be used to pay for monthly premiums for a health plan. Two that could be appropriate for Chris’s employees are:
- Qualified small employer HRA (QSEHRA)
- Individual coverage HRA (ICHRA).
For either type of HRA, the employer reimburses the employee for approved, qualified medical expenses. Generally, these are the same types of expenses that qualify for the medical expense deduction on Schedule A, including health insurance premiums.
Here are some of the features of and differences between these two types of HRAs.
Eligible employer and coverage provided
For a QSEHRA, the employer must have fewer than 50 employees, i.e. not be an applicable large employer (ALE) for ACA purposes, and may not offer any other any type of group health insurance coverage, even dental or vision plans. The employer can opt to provide the QSEHRA only to full-time employees. If extended to part-time employees, the QSEHRA must have the same reimbursement allowance amounts available.
For an ICHRA, the employer may be any size, including ALEs, and may provide the ICHRA to one class of employees and a group health plan to a different class of employees. Classes of employees include full-time and part-time employees, salaried and hourly employees, or employees in different geographic locations. There is a minimum class size that applies (10 employees for employers with fewer than 100 employees) if the employer is offering different plans, such as a group plan and an ICHRA to different classes of employees.
Eligible employee required coverage
An employer may provide a QSEHRA to employees covered by any type of health insurance, including individual plans and group coverage under a spouse’s employer. However, if an employee doesn’t have minimum essential coverage (MEC) or provide proof they have MEC, and they mistakenly receive reimbursements from a QSEHRA for medical care during one or more months they did not have MEC, the reimbursements are taxable income to that employee. In any case, reimbursements are not subject to FICA and Medicare tax withholding.
Eligibility requirements for an ICHRA are stricter: employees must have individual MEC, including Medicare. Employees covered under group plans, or who are uninsured may not participate in the ICHRA. As explained earlier, if there are sufficient employees in a class the employer may have a group plan for one class and an ICHRA in another class. Because individuals with an ICHRA must have individual coverage, reimbursements are not subject to income tax or payroll taxes.
Reimbursement allowance amounts
Employers offering either type of HRA may set different reimbursement maximums based on age and family size. Unused amounts may be rolled over from month to month and from year to year. Note that employers may not simply distribute unused amounts in HRAs to employees as doing so would invalidate the HRA.
An inflation adjusted annual reimbursement maximum applies to QSEHRAs. For 2020 the maximums are $5,250 ($437.50 a month) for single employees and $10,600 ($883.33 a month) for employees with a family. If unused amounts are rolled over to the next year, the maximum reimbursement is still limited to the annual QSEHRA cap for that year.
There are no annual caps with ICHRAs. In addition to setting different maximums based on age and family size employers can set different maximums based on employee classes.
Coordination with the premium tax credit (PTC)
Chris said that one of his employees may have a marketplace plan. For QSEHRAs, if the employee is also eligible for a premium tax credit, the PTC must be reduced by the HRA reimbursement. For ICHRAs, the employee must choose between the HRA or the PTC. They cannot have both.
Making the decision
Both types of HRAs have features that could work well for Chris’s business but both also have restrictions. Before making a decision, Chris needs to find out more about what type of insurance his employees have or plan to have, think about whether he plans to expand this business, and decide how much he intends to reimburse his employees. For instance, if one of his employees is covered under a spouse’s group health plan, he would not be able to offer an ICHRA. On the other hand, if everyone has individual MEC of some type and Chris would like to pay a substantial portion of their premiums the ICHRA may be the better fit.