Essential guide to Health reimbursement arrangements

Understanding Health reimbursement arrangement opportunities

Health reimbursement arrangements (HRAs) represent one of the most powerful tax strategies available to businesses seeking to provide valuable healthcare benefits while maximizing tax deductions. These employer-funded plans allow companies to reimburse employees for qualified medical expenses on a tax-free basis, creating a win-win situation for both employers and employees.

Unlike traditional group health insurance plans, HRAs offer flexibility and cost control that make them particularly attractive to small and medium-sized businesses. Employers can set annual contribution limits, choose which expenses to cover, and maintain complete control over plan design. Meanwhile, employees receive tax-free reimbursements for legitimate medical expenses that might otherwise come from their after-tax dollars.

The strategic value of HRAs extends beyond simple cost savings. These arrangements help businesses attract and retain quality employees while demonstrating a commitment to workforce health and well-being. For tax planning purposes, HRAs provide predictable deductions that can significantly impact a company's tax liability when properly structured and implemented.

Essential eligibility requirements for Health reimbursement arrangements

Before implementing an HRA, businesses must understand the strict eligibility requirements established by federal regulations and tax law. These requirements determine not only whether a company can offer an HRA but also which employees can participate and what expenses qualify for reimbursement.

Business eligibility criteria

The foundation of any HRA implementation begins with business eligibility. Companies must have employees to establish an HRA, as these arrangements are designed explicitly for employer-employee relationships. Sole proprietors without employees cannot establish HRAs for themselves, though they may be eligible for other medical expense deductions.

The business must maintain a written plan document that outlines all aspects of the HRA, including:

• Eligible participants and dependents
• Maximum annual benefit amounts
• Covered medical expenses
• Claims submission procedures
• Plan administration responsibilities

Entity type considerations

Different business entity types face varying restrictions and opportunities when implementing HRAs. C Corporations enjoy the most flexibility, as owners who are also employees can participate fully in HRA benefits. The corporation deducts reimbursement payments as business expenses, while employee-owners receive tax-free benefits.

S corporations face additional complexity due to the treatment of shareholder-employees. More than 2% shareholders cannot receive tax-free HRA benefits in the same manner as regular employees. Instead, reimbursements are typically treated as taxable wages subject to income tax withholding, though not Social Security and Medicare taxes.

Partnerships encounter similar restrictions. Partners cannot receive tax-free medical reimbursements through traditional HRAs. However, a partner's spouse may be eligible to participate as a bona fide employee.

For Schedule C and Schedule F businesses, the sole proprietor cannot establish an HRA for personal use, but can implement arrangements for legitimate employees.

Employee participation requirements

HRAs must be offered on a nondiscriminatory basis, meaning businesses cannot favor highly compensated employees over rank-and-file workers. However, employers can establish different classes of employees with varying benefit levels, provided the distinctions are based on legitimate business criteria such as:

1. Full-time versus part-time status
2. Geographic location
3. Length of service requirements
4. Union versus non-union employees

All eligible employees within each class must receive the same HRA benefits. Employers cannot base participation on individual health status, claims history, or other discriminatory factors.

Types of Health reimbursement arrangements

The healthcare landscape offers several distinct types of HRAs, each designed to meet specific business needs and regulatory requirements. Understanding these variations helps businesses choose the most appropriate arrangement for their circumstances.

Qualified small employer health reimbursement arrangement (QSEHRA)

QSEHRAs are specifically designed for small businesses with fewer than 50 full-time equivalent employees that do not offer group health insurance. This arrangement allows employers to reimburse employees for individual health insurance premiums and qualified medical expenses up to statutory limits.

For 2025, QSEHRA contribution limits are $6,350 (2024 - $6,150) for individual coverage and $12,700 (2024 - $12,450) for family coverage. These amounts are indexed for inflation and adjusted annually. The key advantage of QSEHRAs is their simplicity – they require minimal administrative overhead while providing meaningful benefits to employees.

Employees must have qualifying health coverage to receive tax-free QSEHRA reimbursements. Those without minimum essential coverage will face taxable income on reimbursements, though the employer deduction remains available.

Individual coverage health reimbursement arrangement (ICHRA)

ICHRAs offer the most flexibility for employers of any size, allowing them to reimburse employees for individual health insurance premiums and qualified medical expenses without contribution limits. Unlike QSEHRAs, ICHRAs can be offered alongside or instead of traditional group health plans.

This arrangement enables employers to provide defined-contribution health benefits rather than defined-benefit coverage. Employees can choose individual health plans that best meet their needs while receiving employer contributions through the ICHRA.

ICHRAs require more complex administration than QSEHRAs, including monthly attestations and premium tax credit coordination. However, they provide unparalleled flexibility in benefit design and cost management.

Group coverage health reimbursement arrangement (GCHRA)

GCHRAs, also known as integrated HRAs, work in conjunction with group health insurance plans to reimburse employees for qualified medical expenses not covered by the primary plan. These arrangements typically cover deductibles, copayments, coinsurance, and other out-of-pocket costs.

The integrated nature of GCHRAs means they cannot exist independently – they must supplement an existing group health plan. This arrangement is particularly valuable for employers who want to enhance their existing benefits package without increasing premium costs.

Standard Health reimbursement arrangement

Traditional HRAs predate the specific types mentioned above and continue to operate under established regulations. These arrangements can reimburse employees for qualified medical expenses and, in some cases, health insurance premiums.

Standard HRAs face the most restrictive rules regarding group health plan coordination and, if not properly structured, may conflict with Affordable Care Act market reforms. Many employers have transitioned to newer HRA types that offer more explicit regulatory guidance.

Qualified medical expenses and documentation requirements

The success of any HRA depends on the proper identification and documentation of qualified medical expenses. Understanding which expenses qualify ensures compliance and maximizes the tax benefits for both employers and employees.

IRS-qualified medical expenses

Qualified medical expenses for HRA purposes generally align with those deductible under IRC Section 213. They focus on expenses for the diagnosis, cure, mitigation, treatment, or prevention of disease. These expenses must be primarily for medical care rather than general health or cosmetic purposes.

Common qualified medical expenses include:

• Health insurance premiums and deductibles
• Prescription medications and over-the-counter drugs
• Medical equipment and supplies
• Dental and vision care
• Mental health and substance abuse treatment
• Preventive care and routine checkups
• Medical transportation costs

Documentation and substantiation requirements

Proper documentation is crucial for defending HRA deductions and ensuring compliance with tax regulations. The IRS requires employees to substantiate medical expenses with adequate records that demonstrate the medical nature and amount of each expense.

Required documentation includes:

• Itemized receipts or statements from healthcare providers
• Explanation of Benefits (EOB) statements from insurance companies
• Prescription labels or pharmacy receipts
• Medical necessity documentation for unusual expenses

Employers should establish clear procedures for expense submission and review, including timeframes for submitting claims and requirements for additional documentation when needed.

Prohibited expenses and common mistakes

Certain expenses, specifically, cannot be reimbursed through HRAs, even if they might seem health-related. Understanding these limitations prevents costly compliance errors and potential tax penalties.

Prohibited expenses include:

• Cosmetic procedures not related to medical conditions
• General nutritional supplements and vitamins
• Health club memberships and recreational activities
• Personal use items like toiletries and cosmetics
• Expenses for which employees received other reimbursements

One common mistake involves "double-dipping" – claiming the same expense through multiple tax-advantaged accounts or deductions. Expenses reimbursed through an HRA cannot also be claimed as itemized medical deductions on personal tax returns.

Setting up and administering Health reimbursement arrangements

Successful HRA implementation requires careful planning and ongoing administration to ensure compliance with complex regulations while maximizing benefits for employers and employees.

Plan document development

Every HRA must have a comprehensive written plan document that serves as the legal foundation for the arrangement. This document should clearly define all aspects of the plan, including eligibility requirements, benefit levels, covered expenses, and administrative procedures.

Key elements of an effective plan document include:

• Plan sponsor identification and contact information
• Eligible employee classifications and participation requirements
• Annual contribution limits and benefit calculations
• Covered medical expenses and exclusions
• Claims submission and reimbursement procedures
• Appeal processes for denied claims
• Plan termination and amendment procedures

The plan document should be reviewed annually and updated as needed to reflect regulatory changes or business modifications. Employees must receive a Summary Plan Description that explains their rights and benefits in plain language.

Claims processing and reimbursement procedures

Efficient claims processing is essential for employee satisfaction and regulatory compliance. Employers should establish clear procedures for submitting, reviewing, and processing reimbursement requests.

Recommended claims processing procedures include:

1. Electronic submission systems for faster processing
2. Required documentation standards for all claim types
3. Review timelines and approval workflows
4. Payment methods and schedules
5. Record retention requirements
6. Employee communication throughout the process

Many employers partner with third-party administrators who specialize in HRA management, providing expertise and technology that would be costly to develop internally.

Compliance monitoring and record keeping

HRAs are subject to various federal regulations beyond fundamental tax law, including ERISA, COBRA, and healthcare reform requirements. Ongoing compliance monitoring helps identify potential issues before they become costly problems.

Essential compliance activities include:

• Annual nondiscrimination testing
• COBRA continuation coverage administration
• Privacy and security protection for medical information
• Regulatory filing requirements
• Employee communication and disclosure obligations

Proper record keeping supports compliance efforts and provides necessary documentation for audits or regulatory inquiries. Records should be maintained for at least six years and include plan documents, employee elections, claims history, and compliance testing results.

Tax implications and benefits maximization strategies

Understanding the tax implications of HRAs enables businesses to maximize their benefits while maintaining compliance with complex regulations that vary by entity type and employee classification.

Employer tax benefits

For eligible businesses, HRA reimbursements provide immediate tax deductions as ordinary business expenses. This deduction reduces the company's taxable income dollar-for-dollar, providing significant tax savings, especially for businesses in higher tax brackets.

The timing of deductions depends on the company's accounting method. Cash-method businesses generally deduct reimbursements when paid, while accrual-method businesses may deduct amounts when the obligation becomes fixed and determinable.

Business tax strategies often incorporate HRAs as part of a comprehensive approach to employee benefits and tax optimization. For businesses looking to maximize deductions, combining HRAs with other techniques like Travel expense deductions and Meal deductions can provide substantial savings. The predictable nature of HRA costs allows for effective tax planning and cash flow management.

Employee tax advantages

Qualified HRA reimbursements are excludable from employees' gross income, providing tax-free benefits that significantly enhance compensation packages. This exclusion applies to federal income tax, Social Security tax, and Medicare tax for most employees.

The tax-free nature of HRA reimbursements can provide substantial value compared to equivalent cash compensation. For example, an employee in the 22% tax bracket receiving $1,000 in HRA reimbursements would need $1,282 in additional salary to achieve the same after-tax benefit.

Integration with other benefit plans

HRAs can be strategically combined with other employee benefit plans to create comprehensive packages while maximizing tax efficiency. However, careful coordination is required to avoid conflicts with Health savings accounts (HSAs) and other tax-advantaged arrangements.

Key integration considerations include:

• HSA compatibility restrictions for certain HRA types
• Coordination with flexible spending accounts (FSAs)
• Impact on premium tax credit eligibility for marketplace coverage
• COBRA continuation requirements across multiple plans
• Coordination with vehicle deduction strategies for comprehensive employee benefits

Common implementation challenges and solutions

While HRAs offer significant benefits, businesses often encounter challenges during implementation and ongoing administration. Understanding these common issues and their solutions helps ensure successful program deployment.

Regulatory compliance complexity

The regulatory landscape surrounding HRAs continues to evolve, with new requirements and interpretations emerging regularly. This complexity can overwhelm businesses without dedicated benefits expertise.

Solutions include:

• Partnering with experienced benefits consultants or attorneys
• Utilizing specialized HRA administration platforms
• Joining industry associations for regulatory updates
• Implementing robust compliance monitoring systems

Employee education and communication

Many employees lack familiarity with HRAs and how they differ from traditional health insurance. Poor communication can lead to underutilization and employee dissatisfaction.

Effective communication strategies include:

• Comprehensive enrollment materials and presentations
• Regular educational sessions throughout the plan year
• Online resources and FAQ documents
• Dedicated customer service support for questions

Administrative burden and costs

Managing HRA claims, compliance requirements, and employee communications can create a significant administrative burden for businesses, particularly smaller companies with limited HR resources.

Cost-effective solutions include:

• Third-party administration services
• Technology platforms that automate routine tasks
• Simplified plan designs that reduce complexity
• Outsourcing specialized functions like COBRA administration

Technology and tools for Health reimbursement arrangement management

Modern technology has transformed HRA administration, making these arrangements more accessible and manageable for businesses of all sizes. Advanced platforms streamline processes while ensuring compliance and enhancing employee experiences.

Digital administration platforms

Comprehensive HRA administration platforms handle everything from plan setup to claims processing and compliance monitoring. These systems typically include:

• Automated claims processing and approval workflows
• Integration with payroll and HR information systems
• Employee self-service portals for claims submission
• Compliance monitoring and reporting capabilities
• Document management and record retention features

Instead's innovative platform provides comprehensive HRA management tools that simplify administration while ensuring compliance with complex regulations.

Mobile applications and employee portals

Modern employees expect convenient access to their benefits information and the ability to submit claims from mobile devices. Leading HRA platforms offer mobile applications that enable:

• Photo-based claims submission using smartphone cameras
• Real-time benefit balance checking
• Claims status tracking and history
• Educational resources and plan information
• Push notifications for important updates

Integration capabilities

Effective HRA technology integrates seamlessly with existing business systems to reduce administrative burden and ensure data accuracy. Key integration points include:

• Payroll systems for automated reimbursements
• HR information systems for employee data
• Accounting software for expense tracking
• Benefits administration platforms for comprehensive management

Future trends and considerations for Health reimbursement arrangements

The HRA landscape continues to evolve, driven by regulatory changes, technological advances, and shifting employer and employee preferences. Understanding these trends helps businesses make informed decisions about their HRA strategies.

Regulatory developments

Healthcare policy remains dynamic, with potential changes that could affect HRA regulations and benefits. Recent trends include expanded flexibility for HRA designs and increased contribution limits for certain arrangement types.

Businesses should monitor regulatory developments and be prepared to adjust their HRA plans accordingly. Working with knowledgeable advisors ensures awareness of changes that could impact existing arrangements.

Technology advancement

Artificial intelligence and machine learning are beginning to enhance HRA administration through:

• Automated claims review and fraud detection
• Predictive analytics for benefits planning
• Personalized employee communications
• Enhanced reporting and compliance monitoring

Market evolution

The healthcare benefits market continues to shift toward consumer-directed arrangements that provide employees with more choice and control. HRAs align well with this trend by enabling defined contribution approaches to health benefits.

Employers increasingly view HRAs as tools for cost control and employee satisfaction rather than simply tax strategies. This evolution drives innovation in plan design and administration approaches.

Take the next step in optimizing your business tax strategy. Contact Instead today to learn how Health reimbursement arrangements can reduce your tax liability while providing valuable benefits to your employees.

Frequently asked questions

Q: Can sole proprietors establish Health reimbursement arrangements for themselves?

A: No, sole proprietors without employees cannot establish HRAs for personal use, as these arrangements require an employer-employee relationship. However, sole proprietors may be eligible for other medical expense deductions through their Schedule C filing.

Q: How do Health reimbursement arrangements affect employees' eligibility for premium tax credits?

A: Employees with access to employer-sponsored coverage through certain types of HRAs may not be eligible for premium tax credits on marketplace health plans. The specific rules vary by HRA type and require careful coordination.

Q: What happens to unused HRA funds at the end of the plan year?

A: This depends on the plan design. Employers can choose to allow unused funds to roll over to the following year, forfeit unused amounts, or provide a limited grace period for claims incurred in the previous year.

Q: Can businesses offer different HRA benefits to other classes of employees?

A: Yes, employers can establish different employee classes with varying benefit levels, provided the distinctions are based on legitimate business criteria such as full-time versus part-time status, geographic location, or job function. All employees within each class must receive equal treatment.

Q: How do Health reimbursement arrangements coordinate with Health Savings Accounts?

A: Certain types of HRAs can disqualify employees from HSA contributions, while others are designed to be HSA-compatible. The interaction depends on the specific HRA type and design, requiring careful planning to avoid conflicts.