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Small Business Employee Benefits and HR Blog

Are QSEHRA Reimbursements Taxable?

One of the primary benefits of offering a qualified small employer health reimbursement arrangement (QSEHRA) is the tax advantage available to both small businesses and their employees.

With the QSEHRA, all payments made through the benefit are free of payroll tax to both the business and the employee. Employees can receive QSEHRA reimbursements free of income tax as well, provided they're covered by a health insurance policy providing minimum essential coverage (MEC).

Many QSEHRA participants and small business owners have questions about what this means in practice. In this blog, we’ll go through several common employee scenarios and explain the tax implications of each. We’ll also explain how employees should account for QSEHRA reimbursements while filing income taxes.

Employees with existing major medical insurance

Employees with existing major medical insurance may receive QSEHRA reimbursements free of both payroll and income tax.

Employees may have coverage through a variety of policies, including:

  • individual health insurance purchased through an insurance company or Marketplace,
  • a spouse’s group health insurance,
  • a parent’s family insurance (if the employee is under 26),
  • or government-sponsored programs like Medicare.

Employees without major medical insurance

Employees without major medical insurance can receive QSEHRA reimbursements, but all reimbursements an employee receives while without coverage are subject to income tax. The employee should report all reimbursements as taxable income on their tax return.

These employees will still receive QSEHRA reimbursements free of payroll tax.

Here’s a more detailed examination of how the QSEHRA works for employees without MEC.

Employees belonging to a health care sharing ministry

Health care sharing ministries, such as Medi-Share or Samaritan Ministries, are faith-based organizations that facilitate the sharing of health costs among ministry members in exchange for membership fees.

These ministries don’t qualify as major medical insurance and don’t provide minimum essential coverage. As such, a QSEHRA works much the same for employees belonging to a health care sharing ministry as it does for employees without insurance.

Employees enrolled in a health care sharing ministry can receive QSEHRA reimbursements, but all reimbursements the employee receives while without coverage are subject to income tax. The employee should report all reimbursements as taxable income on their tax return.

These employees will still receive QSEHRA reimbursements free of payroll tax.

Employees who are also business owners

While offering a QSEHRA should primarily be about providing value to employees, federal tax code does allow—and even requires—some business owners to participate in a QSEHRA. This is determined by whether the owner is considered an employee, which is determined by the business’s filing status.

Much like nonowner employees, business owners may receive QSEHRA reimbursements tax-free if they have MEC.

C-corporation owners

Because C corporations are legal entities entirely separate from the owner, owners are common-law employees and eligible for the QSEHRA. All reimbursements the C-corp owner and the owner’s family receive are tax-free if the owner and family have MEC.

Sole proprietors

A sole proprietorship is an unincorporated business owned and run by one individual. There is no distinction between the business and owner, meaning the owner is not an employee. This prevents sole proprietors from participating in a QSEHRA.

However, if the owner of the sole proprietorship is married to a W-2 employee of the business, the owner could gain access to the QSEHRA through their spouse. All reimbursements would be free of payroll and income tax to both the sole proprietorship and the owner’s spouse, provided they have MEC.

Partners

A partnership is a pass-through entity, which means the company is not subject to income tax. Instead, the partners are directly taxed individually. This means partners in a partnership aren’t employees, and thus are not eligible to participate in a QSEHRA.

Similar to sole proprietors, partners can gain access to the QSEHRA if they’re married to a W-2 employee of the business and the spouse isn’t another business partner. If they have MEC, all reimbursements would be free of payroll and income tax.

S-corporation owners

An S corporation is a pass-through entity, meaning the company isn’t subject to income tax. Instead, shareholders (i.e., owners who own 2 percent or more of the company’s shares) are directly taxed individually. This means shareholders aren’t employees and aren’t eligible to participate in the QSEHRA.

Family members, including spouses, parents, grandparents, and children (but not siblings), are also considered shareholders and are unable to participate in a QSEHRA.

This makes tax implications irrelevant.

How to report QSEHRA reimbursements while filing taxes

A small business offering a QSEHRA will report the total employee allowance in box 12 of the employee’s W-2 using code FF. This amount reflects the total allowance the employee could have collected through the QSEHRA; it doesn’t reflect how much the employee actually collected in reimbursements.

Instead, it’s up to the employee to track the total amount of money received through the QSEHRA while they were without MEC. For example, if an employee had MEC from January to June, but canceled their policy effective July 1 and went without coverage through the end of the year, the employee should keep track of the total amount of QSEHRA reimbursements received from July through December. This is the portion considered taxable.

The employee must include this amount in their gross income while filing taxes. This will help them calculate the income tax owed on that amount and pay accordingly.

Conclusion

The QSEHRA offers great tax advantages to both small businesses and their employees. For small businesses, all payments made through the QSEHRA are free of payroll tax. For employees, all reimbursements received through the QSEHRA are free of payroll tax and may be free of income tax, too, if the employee has MEC.

While the greatest tax advantages apply to employees with MEC, all participants benefit from the QSEHRA.

The QSEHRA helps employees pay for a variety of medical expenses, including prescription and nonprescription drugs and premiums for dental and vision policies. While employees without MEC must pay some tax on these reimbursements, the up-front benefit from the business makes health care costs much easier to bear.

And, when employees do gain MEC, they’ll immediately be able to start collecting reimbursements free of income tax.

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