Many companies now offer Health Reimbursement Arrangements (HRAs) in conjunction with high-deductible health plans (HDHPs). HRAs offer some advantages over the perhaps better-known HDHP companion account, the Health Savings Account (HSA). If you’re considering adding this benefit, you might assume, as a business owner, automatic HRA for self employed eligibility. But this may not be the case.

Following The Rules

Whether an owner can participate in his or her company’s HRA depends on several factors. These factors include the organization of the company and the ownership amount of the business by each working owner. Tax-free benefits under an HRA can be available only to:

• Current and former employees (including retirees), and their spouses.
• Covered tax dependents.
• Children who are not age 27 by the end of the tax year.

Owners who are “self-employed individuals” within the meaning of Internal Revenue Code Section (IRC) 401(c) aren’t considered employees for this purpose. Therefore, these specific owners are ineligible to participate in an HRA on a tax-favored basis.

Defining the Self-Employed

Generally, a self-employed individual is someone who has net earnings from self-employment as defined in IRC Sec. 1402(a), accounting for only earnings from a trade or business in which the “personal services of the taxpayer are a material income-producing factor.” Ineligible owners include partners, sole proprietors and more-than-2% shareholders in an S corporation. An employee stock ownership plan (ESOP) of a C corporation doesn’t preclude their tax-favored HRA participation.

The ownership attribution rules in IRC Sec. 318 apply when determining who’s a more-than-2% shareholder of an S corporation, so any employee who’s the spouse, child, parent or grandparent of a more-than-2% shareholder of an S corporation would also be unable to participate in the S corporation’s HRA on a tax-favored basis. A disqualifying individual (whether because of direct or attributing ownership) could, however, be the beneficiary of a qualifying participant’s HRA coverage. This applies if he or she is the qualifying participant’s spouse, tax dependent or child under age 27.

Comparing HRAs to HSAs

Although self-employed individuals can’t receive tax-free HSA contributions through a cafeteria plan, at least they can have HSAs. This relative advantage has led some employers to favor HSA programs over HRA for self employed programs.

But HRAs have other advantages for employers. This includes more control over the spending amount and typically lower costs relative to the nominal amount of the benefits. Meanwhile, the funding of a full HSA contribution must be with cash. HRAs typically are notional accounts that need only be funded when participants incur expenses, and not all participants will incur expenses up to the limit established by the employer. Thus, the decision can seldom be made based on the participation rules alone.

Take a look at our previous post on the HRA HSA FSA Comparison for more information!

Going in smart

Insurance costs for business and control management remains a challenge for most businesses that offer health care benefits. An HRA may be a feasible solution, but make sure you know all the rules going in. Our Chicago accounting services team can help you choose health care benefits that suit you and your employees.