June 26, 2002:
The Treasury Department & the IRS released guidance on HRAs
General Information
On June 26, 2002, the Treasury Department and the IRS released the guidance on Health Reimbursement Arrangements (HRAs), arrangements in which the employee health benefit arrangement provides for employee-controlled reimbursement of medical costs.
"With this new guidance, we clear the way for employers to adopt health plans with patient-directed features so that employees have more choice and greater control over their health care coverage," stated Treasury Secretary Paul O’Neill.
This guidance (a notice and a revenue ruling) provides that medical benefits paid by HRAs meeting certain requirements are not taxable, and generally are not subject to the design requirements for Health FSAs funded through a cafeteria plan.
How Does the IRS Define HRAs?
An HRA is an arrangement that:
- Is paid for solely by the employer and not provided pursuant to salary reduction election or otherwise under a § 125 cafeteria plan;
- Reimburses the employee for medical care expenses (as defined by § 213(d) of the Internal Revenue Code) incurred by the employee and the employee’s spouse and dependents (as defined by § 152); and
- Provides reimbursements up to a maximum dollar amount for a coverage period and any unused portion of the maximum dollar amount at the end of a coverage period is carried forward to increase the maximum reimbursement amount in subsequent coverage periods.
HRAs reimburse medical care expenses for employee, spouse and dependents
To the extent that an HRA is an employer-provided accident or health plan, coverage and reimbursement of medical care expenses of an employee and the employee’s spouse and dependents are generally excludable from the employee’s gross income under §§106 and 105.
Assuming that the maximum amount of reimbursement which is reasonably available to a participant under an HRA is not substantially in excess of the value of coverage under the HRA, an HRA is a flexible spending arrangement (FSA) as defined in § 106 (c )(2).
An arrangement is not treated as an HRA if the arrangement interacts with a cafeteria plan in such a way as to permit employees to use salary reduction indirectly to fund the HRA.
What Benefits can be Offered under an HRA?
To qualify for §§ 106 and 105 exclusions, an HRA may only provide benefits that reimburse expenses for medical care as defined by § 213(d), which are incurred by the employee and the employee’s spouse and dependents (as defined in § 152). This includes amounts paid for premiums for accident or health coverage for current employees, retirees, and COBRA qualified beneficiaries. (Be cautious when allowing reimbursement of health premiums in an HRA. Violations may arise from HIPPA issues and indirect salary reductions funding of the HRA. Also, you need to make sure it complements your plan design.)
If any person has the right to receive cash or any other taxable or non-taxable benefit under the arrangement other than the reimbursment of mecical care expenses, all distributions to employees for the current year become taxable.
A self-employed individual is not considered an “employee” as defined in §401 (c)
Who is Covered under an HRA?
Medical care expense reimbursements under an HRA are excludable under §105(b) to the extent the reimbursements are provided to the following individuals:
- Current and former employees (including retired employees)
- Their spouses
- Their dependents (as defined in §152 as modified by the last sentence of §105(b))
- The spouse and dependents of deceased employees.
The term “employee” does not include a self-employed individual as defined in §401 (c ).
Do the rules for Health FSAs apply to HRAs?
There are differing rules for Health FSAs and HRAs
The proposed regulations relating to health FSAs under §125 state that certain requirements apply whether or not the health FSA is part of a cafeteria plan. Future guidance will modify the proposed regulation under §125 to clarifythat while those rules continue to apply to health FSAs provided pursuant to salary reduction lection under a § 125 cafeteria plan, they do not apply to HRAs.
Because an HRA is paid for solely by the employer and not pursuant to salary reduction, the following restrictions on health FSAs under §125 are not applicable to HRAs:
- The prohibition against a benefit that defers compensation by permitting employees to carry over unised elective contributions or plan benefits from one plan year to another plan year (No use-it or lose-it rule)
- The requirement that the maximum amount of reimbursement must be available at all times during the coverage period (no uniform coverage rule)
- The mandatory twelve-month period of coverage
- Except as otherwise provided in this notice, the limitation that medical expenses reimbursed must be incurred during the period of coverage. (Expenses may be reimbursed in previous periods if employee was covered then.)
As a result, the maximum reimbursement amount for a coverage period (not including amounts carried over forward from previous coverage periods) need not be available at all times during the coverage period.
Also, an HRA may specify a coverage period for a reimbursement amount that is less than twelve months. Although claims incurred during one coverage period may be reimbursed in a later coverage period only if the individual was covered under the HRA when the claim was incurred.
Additionally, the maximum reimbursement amount credited under the HRA in the future (not including amounts carried forward from previous coverage periods) may be increased or decreased. However, if an increase in maximum reimbursement amounts in an HRA favors one or more highly compensated individuals, the HRA may violate these non-discrimination rules.
Who Pays First? HRA or FSA?
Who Pay’s First?
HRA or FSA?
Employer Decides
According to the current § 125 rules, medical expenses may not be reimbursed from a §125 Health FSA if the expense has been reimbursed or is reimbursable under any other accident or health plan. If you apply this rule and coverage is provided under both an HRA and a § 125 health FSA, the amounts available under an HRA must be exhausted before reimbursements may be made from the FSA.
However, the HRA Plan Document can specify that expenses cannot be reimbursed under the HRA until the FSA funds are exhausted. This way funds are not “reimburseable” from the HRA.
Does COBRA Apply?
An HRA must comply with certain COBRA requirements if an individual elect COBRA continuation coverage
An HRA is a group health plan generally subject to the COBRA continuation coverage requirements. If an individual elects COBRA continuation coverage, an HRA complies with these COBRA requirements by providing for the continuation of the maximum reimbursement amount for an individual at the time of the COBRA qualifying event and by increasing that maximum amount at the same time and by the same increment that it is increased for similarly situated non-COBRA beneficiaries (and by decreasing it for claims reimbursed). Premiums are determined under the existing rules in §4980B. In Rev. Rul. 2002-41, Situation 1, a qualified beneficiary who chooses to elect COBRA continuation coverage may only elect the HRA in conjunction with the major medical plan. However, a qualified beneficiary may choose to elect COBRA continuation coverage for only the major medical plan.
What about non-discrimination rules?
Section 105(h) sets forth nondiscrimination rules for self-insured medical expense reimbursement plans. To the extent an HRA is a self-insured medical expense reimbursement plan, the non-discrimination rules under §105(h) apply to the HRA. However, no guidance was provided on how to apply this to an HRA. § 1.105-11(c )(3)(ii) regarding operational discrimination in favor of highly compensated individuals (as defined in §105(h)) also applies. For instance, if an increase in maximum reimbursement amounts in an HRA favors one or more highly compensated individuals, the HRA may violate these non-discrimination rules.
What happens to a remaining balance?
An HRA may continue to reimburse a retired employee for medical expenses
An HRA may continue to reimburse former employees or retired employees for medical care expenses after termination of employment or retirement (even if the employee does not elect COBRA continuation coverage). The plan may also provide the maximum reimbursement amount available after retirement or other termination of employment is reduced for any administrative costs of continuing such coverage. Additionally, an HRA may or may not provide for an increase in the amount available for reimbursement of medical care expenses after the employee retires or otherwise terminated employment (even if the employee does not elect COBRA continuation coverage).
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HRA • SECTION 105 Health Reimbursement Arrangements |
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HSA • SECTION 223 Health Savings Accounts |
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SECTION 213 Reimbursable / Unreimbursable Expenses |
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