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Q&A: New HRAs for small employers
By Jeffrey Herman on February 10, 2017 at 8:00 AM

Q&A on chalkboardThanks to the 21st Century Cures Act, beginning Jan. 1, 2017, some employers can now offer employees a new type of health reimbursement arrangement, called a Qualified Small Employer HRA. Primarily governed by 26 U.S.C. § 9831(d), these HRAs are designed to help subsidize employees’ purchase of health coverage on the exchange, although they can also be used to help pay for other medical expenses.

The following questions and answers explain how these new HRAs work.

Q: What employers can offer a Small Employer HRA?

A: An eligible employer must have fewer than 50 full-time employees and must not offer a group health plan to any of its employees.

Q: What employees can participate in a Small Employer HRA?

A: A Small Employer HRA must be provided to all eligible employees. Employers have some leeway to restrict eligibility, however. For example, employers can exclude:

  • Employees who have not completed 90 days of service;
  • Part-time or seasonal employees;
  • Certain employees subject to a collective bargaining agreement; and
  • Certain nonresident aliens.

Q: What expenses can be reimbursed by a Small Employer HRA?

A: A Small Employer HRA can reimburse employees for “medical care” incurred by the employee and, if the HRA allows it, by the employee’s family members. “Medical care” is broadly defined in 26 U.S.C. § 213(d), and includes health insurance premiums, transportation costs for obtaining necessary care, and costs for the “diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.” For more information on eligible medical expenses, see IRS Publication 502.

Q: Are there limits on reimbursement?

A: Yes. For 2017, the maximum amount that can be reimbursed under the HRA is $4,950 (or $10,000 for an HRA that also reimburses the medical expenses of family members). If an employee is covered by the HRA for only some months of the year, the maximum is prorated accordingly. In future years, the maximum will be adjusted for inflation. The maximum reimbursement allowed for a particular employee for the year is referred to as his or her “permitted benefit.”

Q: Can the benefits vary at all?

A: Yes. Generally, benefits must be provided on the same terms to all eligible employees. However, the amount of benefits can be tied to a reference policy on the exchange (e.g., the second-lowest-cost silver plan in the market). As the price of the reference policy would vary based on an employee’s age (and, if applicable, the age of his or her family members and the number of family members), the amount of the permitted benefit can vary accordingly. This way, the permitted benefit more closely aligns with the costs the employee will actually face on the exchange. The reference policy designated in the HRA must be the same for all employees.

Q: Do employees have to have health insurance coverage?

A: Yes. If an employee does not have “minimum essential coverage” and is nonetheless enrolled in the Small Employer HRA, the payments or reimbursements from the HRA may be included in the employee’s gross income. However, even if an employee is already enrolled in minimum essential coverage (e.g., through a spouse’s or parent’s employer-sponsored plan), he or she can still participate in the HRA, but seek reimbursement for other types of medical expenses.

Q: Can employees still qualify for a tax credit on the exchange?

A: Yes, but it will be difficult. An employee enrolled in a Small Employer HRA is already receiving tax-free financial assistance to help pay for coverage (i.e., reimbursement from the HRA). To account for this, an employee can be eligible for a tax credit only if the monthly cost of premiums on the exchange — above and beyond the employee’s monthly permitted benefit under the Small Employer HRA — exceeds 9.5 percent of the employee’s household income. That way, the employee gets a tax credit based only on the unreimbursed costs he or she faces on the exchange.

To make this calculation more confusing, the cost of premiums on the exchange is not determined based on the actual cost of the policy the employee buys; rather, it is based on the cost of self-only coverage under the second-lowest-cost silver plan in the market. This means that an employee who must purchase coverage for his or her family members — the total premiums of which may exceed 9.5 percent of the household income — may nonetheless be ineligible for a premium tax credit, which only considers the cost of self-only coverage.

Finally, even if an employee is eligible for a premium tax credit, that credit gets reduced dollar-for-dollar each month by 1/12 of the amount of the employee’s permitted benefit.

Q: Are Small Employer HRAs subject to the “Cadillac Tax”?

A: Theoretically, yes. The Cadillac Tax is an oft-ridiculed tax on employer-sponsored health plans that are too expensive. The goal is to discourage health plans with benefits that are so generous, enrollees will seek unnecessary care. The tax is currently set to go into effect in 2020, if not repealed before then.

However, the tax is unlikely to apply in the case of a Small Employer HRA. Put simply, the tax is equal to 40 percent of the difference between an employee’s permitted benefit under the Small Employer HRA and an “annual limitation.” The annual limitation is an arbitrary amount Congress has chosen to define which plans should be taxed. This amount is set very high. In 2018 (if the tax actually goes into effect in 2020, these amounts will be adjusted for inflation), the annual limitation would be $10,200 for individual coverage and $27,500 for any other type of coverage. In 2020, these limits will almost certainly far exceed an employee’s permitted benefit, resulting in no applicable tax. However, if the amounts are adjusted at different rates over time, at some point the tax could become applicable.

Q: Are Small Employer HRAs subject to the Employee Retirement Income Security Act of 1974 (ERISA)?

A: Generally, yes. Unless it meets a separate exception to ERISA, a Small Employer HRA must be established and maintained pursuant to a written plan document, furnish Summary Plan Descriptions, apply mandatory claims procedures, adhere to fiduciary duties, and comply with other requirements under ERISA.

However, Small Employer HRAs are generally excluded from “group health plan” requirements under ERISA and the Tax Code.

Q: Are Small Employer HRAs subject to COBRA continuation coverage?

A: No. Small Employer HRAs are specifically excluded from COBRA continuation coverage requirements.

Q: How are Small Employer HRAs funded?

A: The HRA must be funded solely by the employer. There can be no employee contributions of any kind, including salary reduction contributions.

Q: Do employers have to provide any special notices to employees?

A: Yes. An employer must provide a notice to each eligible employee that includes:

  • The amount that would be the employee’s permitted benefit for the year;
  • A statement that the employee should report his or her permitted benefit to a health insurance exchange if the employee applies for advance payment of a premium assistance tax credit; and
  • A statement that if the employee is not covered by any minimum essential coverage for a month, any reimbursements under the Small Employer HRA may be includible in gross income.

The notice must be provided at least 90 days before the later of the beginning of the year or the date on which the employee will first be eligible. If a compliant notice is not timely provided, the employer must pay a tax equal to $50 for each failure, subject to a maximum of $2,500 (i.e., no more than 50 violations will be penalized).

Q: Does any information have to be reported on an employee’s W-2?

A: Yes. An employee’s permitted benefit must be reported on his or her W-2.

If you have other questions about Small Employer HRAs, please contact an attorney in our Employee Benefits practice group.

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