Can you offer an HRA to 1099 contractors?

Offering comprehensive health benefits is a top priority for employers looking to keep their employees happy long-term. But choosing a health benefit can get complicated when your workforce includes 1099 contractors. While health reimbursement arrangements (HRAs) are a flexible and tax-advantaged option for employees, they come with specific requirements, and not every type of employee can participate.

This article will break down the eligibility rules for HRAs and 1099 contractors, and what alternative health benefits are available to help you support your entire team.

In this blog post, you’ll learn:

• Why 1099 contractors aren’t eligible to participate in HRAs according to employee eligibility rules.
• How HRAs work, including the different types available.
• What alternative options can help you support 1099 contractors compliantly.

What is an HRA?

An HRA is an employer-funded health benefit that allows you to reimburse employees tax-free for their qualifying out-of-pocket costs, such as prescription medication, doctor visits, and mental health services. Depending on the type of HRA and its plan design, your employees’ individual health plan premiums may also be eligible for reimbursement.

To offer an HRA, an employer must have at least one full-time W-2 employee. There are no minimum participation requirements; however, some HRAs have maximum company size limitations and contribution restrictions.

The following are the three most popular types of HRAs:

1. The individual coverage HRA (ICHRA): An ICHRA is a flexible health benefit available to employers of all sizes. It has no maximum contribution limits, and you can adjust allowances by age, family size, or employee class. Better yet, if you’re an applicable large employer (ALE), you can use an ICHRA to meet the ACA’s employer mandate requirements, as long as your benefit follows annual affordability standards.
2. The qualified small employer HRA (QSEHRA): A QSEHRA is for small business owners with fewer than 50 full-time equivalent employees (FTEs). The Internal Revenue Service (IRS) sets maximum annual contribution limits; however, there are no minimum limits. All full-time W-2 employees are automatically eligible to use the benefit if they have qualifying coverage. Employers can also offer the QSEHRA to their part-time workers.
3. The group coverage HRA (GCHRA): A GCHRA is for companies of any size that offer traditional group health insurance. With a GCHRA, employees can receive tax-free reimbursements for out-of-pocket medical costs and services their group plan doesn’t fully cover, such as copays and deductibles. However, group plan premiums are ineligible for reimbursement. Lastly, GCHRAs have no maximum contribution limits and come with customization options.

Regardless of the HRA you offer, contributions are tax-deductible and payroll tax-free for employers, while employees don’t have to pay federal income tax on HRA reimbursements. However, you or your HRA administrators must set up formal plan documents to stay compliant and receive these tax benefits.

Can you offer an HRA to 1099 contractors?

No, 1099 contractors can’t participate in an HRA. This is because the federal government considers HRAs employer-sponsored health plans under Internal Revenue Code Section 105.¹ Generally, only common-law employees are eligible to participate in formal employer-sponsored health plans. 1099 contractors are considered self-employed, so they can’t use the benefit.

HRAs can only cover W-2 employees (both full- and part-time workers) and their eligible dependents. Certain business owners can participate depending on how they file their tax returns.

Additionally, employees must have certain types of coverage to participate in an HRA:

1. To use a QSEHRA and receive tax-free reimbursements, employees must enroll in a health plan that provides minimum essential coverage (MEC). This includes qualified individual health insurance, group coverage through a spouse’s employer, or coverage through a parent’s group plan.
2. If you’re offering an ICHRA, your employees must have a qualifying form of individual health insurance coverage. Some examples of eligible coverage are ACA-compliant individual health plans purchased on a public or private exchange, Medicare Parts A and B, Medicare Part C, and catastrophic policies for those who qualify.
3. Only employees who enroll in their employer’s group health plan can use a GCHRA.

What is an alternative health benefit option for 1099 contractors?

A common alternative to an HRA is a taxable health stipend. With a stipend, you can provide a fixed amount of money to your employees, typically as extra money added to their paychecks, to help them pay for health insurance premiums and other out-of-pocket medical expenses.

One of the biggest advantages of stipends is that they’re informal, and the federal government doesn’t consider them an employer-sponsored health plan. This means that any type of worker can participate — even 1099 contractors and international employees. Stipends are flexible, so you contribute any amount that fits your budget and offer payments as a one-time bonus or on a recurring basis. You can compliantly offer both a health stipend and an HRA so all your staff — whether 1099 or W-2 workers — can receive financial help to pay for their medical bills.

However, employees must pay income taxes on any stipend money they receive throughout the year, possibly putting them in a higher tax bracket. Additionally, the way a stipend works isn’t a formal process. By law, you can’t require your employees to use their stipend on health expenses or request that they submit claim documentation for plan premiums or other medical costs. So, there’s no guarantee your employees won’t use the funds on non-healthcare items.

Another option is to not offer health benefits to 1099 contractors. Self-employed independent contractors can deduct their health insurance premiums, giving them an advantage in choosing their own health coverage.

Conclusion

HRAs are a great way to reimburse employees for medical expenses, but they’re only for W-2 workers. Because the IRS considers 1099 contractors as self-employed, they aren’t eligible to participate in HRAs, and choosing to reimburse a 1099 contractor through the benefit could result in employee misclassification and costly penalties. But luckily, taxable health stipends can provide a simple, compliant way to help your contractors with their medical expenses.

If you want to offer a personalized HRA to your W-2 employees, PeopleKeep by Remodel Health is here to help you design, implement, and manage your perfect benefit. Contact us today to learn more!

References

1. 26 U.S. Code § 105