When an HRA is compliant with the IRS rules, employers can reimburse health expenses with money that is free of payroll taxes for both the employer and employee—and free of income tax for the employee, as long as the employee has health insurance that provides minimum essential coverage (MEC).
To get the tax benefits, however, an HRA must follow IRS procedures, including strict rules about setting up formal plan documents.
In this post, we'll go over three steps to make sure your organization’s's health insurance reimbursement is tax-free.
The IRS has clear rules that govern how HRAs work and how employers must set them up to be compliant.
To get the tax benefits, an HRA must meet the following requirements:
- 100 percent employer-funded (employees can’t contribute).
- The organization can’t fund its contribution through wage deductions—even if the employee agrees to it.
- Employees must have MEC to get reimbursements free of income tax. If employees do not have MEC, they must report reimbursements as taxable income at the end of the year.
- Formal plan documents must define qualified medical expenses.
Certain types of HRAs, like the qualified small employer HRA (QSEHRA), have annual contribution limits, while others, like the individual coverage HRA (ICHRA) and the group coverage HRA (GCHRA), do not.
Curious which HRA might be right for your organization? Take our quiz to find out
To be compliant, healthcare reimbursement plans must have formal plan documents that describe how the plan is managed, what expenses are reimbursable, and what documents are required to demonstrate compliance.
If an employer doesn’t want to set up compliant documents and procedures, it can just give employees a raise or a health insurance stipend. However, the organization will pay payroll tax on this extra money, and employees will pay both payroll and income tax.
The tax-advantaged nature of HRAs makes them a good option for employers that want to offer personalized, flexible health benefits to their employees. Compliance is key, however. Without it, employers and their employees can miss out on the tax savings. Using HRA administration software like PeopleKeep, organizations can set up a fully compliant plan in minutes that they can manage in minutes per month.
This post was originally published November 30, 2018. It was last updated October 21, 2020.