Reimbursing Employees for Medical Expenses

Under a Health Reimbursement Arrangement (HRA) an employer can reimburse an employee for medical expenses paid.  There is no limit on the contribution amount.  However, the contribution is limited to qualified costs (Code Section 419), the amount reasonably necessary to fund the plan (Code Section 419A) and cannot be deferred compensation (Code Section 404).  It is deductible by the employer and is not included in the income of the employee.

Guidelines are provided by Notice 2002-45 "IRS Provides Rules on Health Reimbursement Arrangements" and Code Section 105 -- Accident and Health Plans:

  1. Must set up an actual HRA plan solely funded by the employer and not pursuant to salary reduction election or otherwise under a Section 125 cafeteria plan.
  2. All disbursements must be substantiated medical care expenses as defined by Section 213(d) of the Internal Revenue Code.  For IRS Code Section 213(d) eligible medical expenses, refer to Publication 502 titled, "Medical and Dental Expenses."
  3. Employees are divided into "classes" and the employer determines the amount, if any, they wish to contribute for each class.
  4. Cannot discriminate in favor of "highly compensated individuals1" as to eligibility to participate.  To qualify, an HRA must cover:
    1. 70% or more of all employees or 80% or more of all employees eligible for benefits OR
    2. Such employees as qualify under a classification set up by the employer and found by the Secretary not to be discriminatory in favor of highly compensated individuals. 
  1. However, the HRA can exclude employees with less than 3 years of service, employees who are under age 25 and part-time or seasonal employees.
  2. Amounts not disbursed, can be carried over from year-to-year.
  3. Cannot disburse unused benefits to the employee, even if there is separation of employment.
  4. Is not retroactive, can only reimburse for medical expenses incurred after the plan is set up.
  5. Contributions to the plan can be made as a lump sum or monthly or some other arrangement.
1Highly Compensated Individual (Code Section 105(h)):   
(A)  one of the 5 highest paid officers,
(B)  a shareholder who owns more than 10% of stock of the employer or,
(C)  among the highest paid 25% of all employees (excluding 4c. above)

If you have any questions, do not hesitate to contact the professionals at Dana S. Beane & Company, PLLC

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