Ever since the 21st Century Cures Act introduced the qualified small employer health reimbursement arrangement (QSEHRA) back in 2017, many small employers have had questions about the benefit’s taxation.
In order to administer their QSEHRA compliantly, employers need to understand how the QSEHRA is taxed, which filing requirements they may be subject to, and how they should report the benefit on their employees’ W-2s.
The IRS has covered all of these topics and more in IRS Notice 2017-67. Lucky for you, we’ve summed up its findings here so you don’t have to sift through its 59 pages looking for answers.
In this article, we’ll go over the IRS reporting guidelines for the QSEHRA as well as other general taxation questions to make sure you and your organization are IRS compliant.
What are the basic rules surrounding QSEHRA taxation?
The QSEHRA was created as a formal, tax-free benefit. In practice, that means that reimbursements issued through the QSEHRA are always free of payroll tax for small organizations and their employees.
Reimbursements can be free of income tax for employees, too, if they have minimum essential coverage (MEC).
Organizations using an HRA save an average of 27% for single plans and 52% for family plans compared to organizations that only use a group health insurance plan.
How does my organization report the QSEHRA on my employees’ W-2s?
Small employers offering a QSEHRA must report the benefit on every eligible employee’s W-2.
Box 12, code FF is reserved specifically for the QSEHRA benefit. Organizations should report the total amount of allowances the employee was entitled to receive during that calendar year, without regard to the amount of payments or reimbursements the employee actually received.
The permitted benefit amount should include only newly available QSEHRA funds. Any carryover amounts from previous years should not be included.
If your organization uses a non calendar-year QSEHRA, you should report a prorated amount of the permitted benefit for the calendar year.
For example, if you offer $200 a month and your QSEHRA plan year begins on June 1, 2021, you would report $1,400 on the employee’s 2021 W-2. (That’s $200 times seven months of permitted benefit in 2021).
Similarly, if an employee’s eligibility or allowance changes during the year, the company should prorate the amount reported on their W-2 to reflect the change.
Here’s how that works: Say an employee is eligible for $200 a month as a self-only employee from January 1, 2021, to May 31, 2021, and $400 as a married/family employee from June 1, 2021, to December 31, 2021.
In this case, the employer should report $3,800 on the employee’s 2021 W-2. (That’s $200 times five months of permitted self-only-status benefit plus $400 times seven months of permitted family-status benefit).
How does my organization account for QSEHRA reimbursements that are taxable?
Employees who don’t have MEC can still receive reimbursements through the QSEHRA, but those reimbursements are subject to income tax.
Organizations should track employees’ coverage status throughout the year and report any reimbursements made while the employee didn’t have MEC as taxable income on their W-2.
Specifically, any taxable reimbursements should be included as other compensation in box 1 with their wages, tips, and other compensation.
If you find out an employee doesn’t have MEC after filing their W-2, you should provide the employee with a W-2c form, Corrected Wage and Tax Statement, and file the form with the Social Security Administration (SSA).
These payments won’t affect the amount reported in box 12, code FF.
How does my organization account for other taxable QSEHRA reimbursements?
Some organizations offer other taxable reimbursements through their QSEHRA, including over-the-counter drugs purchased without a doctor’s note and premiums paid on a pretax basis for an employee’s spouse’s group health policy.
If this is the case for your organization, you’ll report the amounts paid to employees that year as wages subject to tax withholding in box 1.
Just like taxable payments for employees without MEC, these payments won’t affect the amount reported in box 12, code FF.
What are my organization’s Patient-Centered Outcomes Research Institute (PCORI) fee responsibilities?
Because the QSEHRA is a self-insured health plan, it’s subject to the Patient-Centered Outcomes Research Institute (PCORI) fee. This fee helps fund the PCORI’s research initiatives.
Organizations offering a QSEHRA must report this fee annually on IRS Form 720. The fee is based on the number of eligible employees included in the benefit for that tax year.
What if my organization offers an individual coverage HRA?
The individual coverage HRA (ICHRA) is another option for organizations of all sizes to reimburse their employees for their medical expenses.
Unlike the QSEHRA, there are no W-2 reporting requirements for the ICHRA. However, you’re not totally out of the woods…
Offering the QSEHRA comes with great benefits, but it also means your organization faces new reporting and tax-filing requirements—including on your employee’s W-2s. While this article offers general guidelines, we recommend that you contact your certified public accountant for additional help.
This article was originally published on July 24, 2018. It was last updated April 2, 2021.