The following outline details the federal regulations governing HRAs as well as plan design issues that are not governed by federal regulations and are therefore left to the employer’s discretion. The topics addressed in this outline are as follows:

• HRAs must be funded solely by the employer

• HRAs may only reimburse participants for medical expenses

• HRAs may only reimburse participants for expenses incurred by employees, former employees, retired employees, their spouses and/or their dependents

• HRAs may allow employees to roll over unused funds to subsequent plan years

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The costs of coverage and reimbursements are tax exempt for participants and are deductible as ordinary and necessary business expenses for the employer.

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HRAs must be funded solely by the employer

Employer may not fund the HRA through a salary reduction election

a.  Any salary reductions for other health plans may not exceed the "actual cost" of those plans or the excess salary reduction will be deemed to attributable to the HRA
b. Employers may safely use the COBRA premium rate for other health plans to determine their "actual cost"

There are no specific dollar limitations on the amount an employer may credit to an HRA

• Code Sections 419 and 419A limitation on contributions do not apply to HRAs that do not place HRA funds into trusts

• Those limitation do apply to HRAs that are funded using trusts and VEBA’s

Employers may fund HRAs with annual lump sums or on a per pay period basis.

a.  HRAs are not subject to the "Uniform Coverage Rule" applicable to FSAs
The "uniform coverage rule" is often referred to as "employer at risk"
For the convenience of participants, the employer is free to provide uniform coverage
b.  Employer’s may restrict reimbursements to current account balances

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HRAs may only reimburse "medical expenses" incurred while the employee is a participant in the plan.

"Medical Expenses"

• HRAs may reimburse for almost any expense which meet the definition of "medical expenses" under I.R.C. Section 213

• Cosmetic procedures are not "medical expenses"

• OTC drugs are not "medical expenses" (they might be in 2003 – stay tuned)

• The employer may exclude any type of medical expense from reimbursement to limit reimbursement liability

• Group health insurance premiums paid through the employer’s Cafeteria Plan are not reimbursable

• HRAs may reimburse employees for COBRA and LTC premiums (but not LTC services). Disability premiums are not reimbursable by HRAs

• Expenses reimbursed by an HRA are not deductible by the employee (but the reimbursement is tax exempt)

Timing

1.  Expenses must be incurred after the HRA is adopted and after the employee is enrolled in the HRA
2.  Expenses from previous years may be reimbursed with funds contributed to an HRA in the current plan year

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HRAs may only reimburse participants for expenses incurred by employees, former employees, retired employees, their spouses and/or their dependents.

Self-employed individuals may not be covered under an HRA.

a.  This includes partners in partnerships, members of LLC’s and 2% shareholders of S-Corporations
b.  Rules of Attribution do apply

Domestic Partners may also be covered under an HRA

• Domestic Partners qualifying as a tax dependent of employee are covered

• For Domestic Partners not-qualifying as a tax dependent of employee

i. The value of the coverage (determined on a reasonable basis) is taxed to the employee

ii. Reimbursements made for expenses of the non- tax dependent domestic partner are not taxed

• Merely taxing the reimbursements when they occur is a violation

• Consult legal counsel prior to excluding Domestic Partners to avoid violations of state and local non-discrimination laws

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The employer has extremely wide latitude in establishing how any unused HRA funds are handled through plan design.

• The employer may permit only a specified amount or percentage of any unused funds to carry forward to subsequent coverage periods

• Employers may establish vesting schedules for carry over amounts subject to Section 105(h)

• Unused amounts can never be cashed out

• They must not be converted to a severance arrangement

• They must not be provided as a death benefit

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The employer can establish an HRA in conjunction with any type of major medical plan it chooses and can even establish an HRA without having a major medical plan

HRAs can be independent of a major medical plan

• Unlike MSAs, HRAs do not require any specific policy conditions

• An employee can have both an MSA and an HRA

• This situation might arise if an employee had an MSA at a previous employer

• The MSA and HRA must cover different expenses

HRAs can be bundled with a major medical plan

• An employer can require an employee to participate in health coverage in order to be covered by the HRA, or

• An employer can permit employees covered under other plans (or not covered at all) to be covered by the HRA

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The general rule is that expenses eligible for reimbursement from both an HRA and a Health FSA must be paid first by the HRA.

Exception

• HRA Plan Document can be written to require a Health FSA to pay first

• This is done by making the HRA the "payer of last resort"

HRA design considerations

• Advantages of HRA as payer of last resort

a.  Reduces or defers employer liability by forcing employee to use Health FSA contributions prior to having employer make reimbursements from HRA

b.  Helps Health FSA participants use up forfeitable dollars and save HRA dollars that can carry over to subsequent plan years

• Disadvantages of HRA as payer of last resort

a.  Employees who elected Health FSA to pay for expenses not covered by insurance or HRA may not have adequate Health FSA funds to pay those expenses

b.  Discourages employees from contributing dollars to Health FSA resulting in higher tax liability for employer

c.  Possible solution to this problem is to permit duplicate Health FSAs with one paying for expenses which the HRA also covers and one paying for expenses the HRA does not cover (ie, vision and dental)

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HRAs are subject to the non-discrimination rules contained in I.R.C. Section 105. Those rules prohibit discrimination in favor of highly compensated individuals as to eligibility to participate and the benefits provided by the HRA. Failure to follow these rules will result in reimbursements to all highly compensated employees being taxed.

Non-Discrimination Rules

1. Definition of Highly Compensated Individuals

a.  one of the 5 highest paid officers
b.  shareholders who own more than 10% of the company
c.  one of the highest paid 25% of all employees

2. Eligibility Test

a.  Plan must benefit at least 70% of all non-excludable employees; or
b.  Plan must benefit at least 80% of all eligible employees and at least 70% of all non-excludable employees are eligible to join the plan
c.  In order to be excluded for testing purposes, excludable employees also must be excluded from participation in the HRA by the terms of the plan
d.  Excludable employees include:

• employees with less than 3 years of service

• employees who are under age 25

• employees who are part-time or seasonal

• employees covered by a collective bargaining agreement

• employees who are non-resident aliens with no U.S. source income

3. Benefits Test

• all benefits provided for participants who are highly compensated individuals must be provided for all other participants

• the easiest way to conform to this requirement is to have uniform benefits for all employees

4. Taxation of Highly Compensated Individuals

• Taxed on 100% of benefits not provided to all non-highly compensated individuals

• Taxed on a fraction of benefits provided when eligibility test is not met based on amount of benefits provided to all highly compensated individuals divided by amount provided to all participants

Legal Discrimination

• Multiple HRAs with different rules for distinct employee groups

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HRAs are subject to the same COBRA’s continuation of coverage rules as other employer sponsored group health plans.

A.  Standard COBRA definitions

• Covered Individuals

• Qualifying Events

• Period of Coverage

B.  Level of coverage available to COBRA beneficiaries

• Determined at the time of the qualifying event

• Includes the previously unreimbursed amount of any carried over balances from participant’s previous years’ coverage under the HRA as well as remaining current year HRA balance

a.  IRS informally believes current year HRA balance for qualified beneficiary should be determined based on year to date reimbursements for that qualified beneficiary
b.  Without further formal guidance from the IRS, employers could reduce current year HRA balances by reimbursements made for any qualified beneficiary of the participant’s account

C.  Future Annual Accruals

1.  Qualified Beneficiaries who elect to participate in COBRA are entitled to increases to their HRA accounts just as if they were employees

a.  They must receive the same amount of increases
b.  The increases must be available at the same time they are available to employees

2.  COBRA Participants must be able to spend the accruals in the same manner as employees

a.  If employees can use accruals to pay for previous year expenses, so can COBRA participants
b.  COBRA participants can use the accounts to pay for whatever employees can be reimbursed for

D. Applicable Premiums

1.  No substantial IRS guidelines in calculating proper amount

a.  COBRA premium should be the same for qualified beneficiaries regardless of account balance at the time of the qualifying event
b.  COBRA premium can be different for qualified beneficiaries with different current coverages (ie, different annual HRA limits based on deductible elected)

2.  Premium should reflect the cost to provide coverage offered under the plan

a.  Actuarial determinations would be best

i.  Data regarding HRA utilization is insufficient at this time to make accurate calculations
ii.  Actuarial determinations will be cost prohibitive to small employers

b.  Other methods of determining appropriate amount

i.  For the first year, base premiums on quotes provided by insurance carriers

ii.  For subsequent years, base premiums on client’s HRA claims experience

iii.  Further I.R.S. guidance and industry figures should be available in future years

E.  Benefits of Bundling HRA with Major Medical Coverage with regards to COBRA

1.  HRAs bundled to a major medical plan can also be tied to those plans for COBRA purposes
2.  Qualified Beneficiaries who want to retain access to HRA balances must also pay the COBRA premiums for the health insurance
3.  This increased cost deters Qualified Beneficiaries from electing COBRA simply to retain access to small HRA balances

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HRAs are also subject to HIPAA, ERISA and I.R.C. Sections 419 and 419A.

A.  HIPAA

Non-Discrimination Requirements

a.  group health plans (including HRAs) may not condition eligibility on health related factors
b.  the fact that healthy participants will be able to carry over more funds than unhealthy participants does not violate HIPAA

Portability Requirements

• HRAs must issue certificates of creditable coverage

• HRAs must honor certificates of creditable coverage supplied by new hires

Privacy Requirements

B.  ERISA

Reporting Requirements (Form 5500)

• funded (or trusted) plans must file

• unfunded (general assets of the employer) with more than 100 participants at the beginning of the plan year must file

• church and government plans are exempt

Disclosure Requirements

a.  Summary Plan Descriptions and Summaries of Material Modifications
b.  Access to Plan Documents
c.  Notification of rights to appeal denials of claims for reimbursement

C.  I.R.C. Section 419 and 419A

1.  Employer’s deductions for HRA funding

• deductions can only be made once participants have been reimbursed

• this applies to carry over accruals as well

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