Health Reimbursement Arrangements: Employer-Provided Medical Coverage

The business enterprise presents taxpayers with numerous tax planning opportunities. Many of these tax planning opportunities include pulling money out of the entity in a way that benefits both the business and its owners and employees on an after-tax basis. As with employer-provided education benefits, employers may be able to minimize their tax obligations by reimbursing employees for employee medical costs.

A health reimbursement arrangement (HRA, or “health reimbursement account”) is simply a pool of money set aside by an employer to reimburse employee and retired employee medical costs or to pay employee insurance premium costs.

If the HRA is structured right, the funds paid to employees are not taxable to the employee (as confirmed in Private Letter Ruling 200708006) and the costs are deductible by the employer (as an ordinary and necessary business expense).

Unlike Heath Savings Accounts (HSAs), employees are not permitted to contribute to the HRA, the HRA remains with the employer after the employee leaves the company, employees are not required to be covered by (or pay for) an insurance plan, and HRAs are open to employers of all sizes (in contrast to the small business requirement for HSAs). Moreover, HRA employer contributions are not mandatory and HRAs are not necessarily subject to some of the self-dealing and discrimination rules imposed on other tax-favorable arrangements.

In addition to these benefits, HRAs, in theory, motivate employees to remain with the employer. HRAs may also motivate employees not to take excessive sick leave or vacation days, because employers can structure the HRA to contribute an additional amount to the HRA based on unused sick and vacation days. HRAs can also result in substantial savings to the employer and employee as direct payments are often less expensive than insurance premium payments.

HRAs are yet another option available to employers that may allow the employer to expand their business and realize tax savings in the process. Employers should consult with their tax attorney to determine whether a HRA is right for their business.