Q&A Health Reimbursement Arrangements (HRAs)

October 28, 2008

Which individuals cannot participate tax free in an HRA?

Self-employed individuals, partners in a partnership and more than 2% shareholders in an S Corporations cannot participate in HRAs tax free as provided in IRS Notice 2002-45.

What items can be reimbursed under an HRA?

An employer can reimburse any designated medical expenses as provided in Code Section 213(s) and premiums for accident or health coverage for current employees, retirees, and COBRA qualified beneficiaries, as provided in IRS Notice 2002-45.

Can an employer vary the amount it contributes for retiree medical benefits under an HRA depending on an employee’s age and service?

Yes.  It is not a violation of the nondiscrimination rules under Code Section 105(h) as provided under Treasury Regulations Section 1.105-11.

Is there any nondiscrimination requirements that an employer must met when sponsoring an HRA?

Yes. HRAs are subject to the nondiscrimination requirements described in Code Section 105(h). HRAs are considered nondiscriminatory only if they do not favor highly compensated individuals with regard to eligibility to participate or the type of benefits provided.

Under Code Section 105(h)(3), an HRA is discriminatory for eligibility unless it benefits:

  • 70 percent or more of all employees;
  • 80 percent of employees eligible to benefit, as long as 70 percent or more employees are eligible to benefit under the plan; or
  • a nondiscriminatory classification of employees.

HRAs are discriminatory for benefits under Code Section 105(h)(4) if the type and amount of benefits available to highly compensated individuals are not also available on the same basis to other participants. The comparison is based on benefits subject to reimbursement, rather than actual benefit payments or reimbursements under the plan, and on dollar amounts, rather than percentages of pay.

For purposes of these tests, highly compensated individuals are defined in Code Section 105(h)(5) as those who are:

  • among the five highest-paid officers of the employer,
  • shareholders who own more than 10 percent in value of the employer’s stock, or
  • the highest paid 25 percent of all employees.

Under Code Section 105(h)(1), excess reimbursements by highly compensated individuals in discriminatory plans are treated as taxable benefits.