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Health Reimbursement Arrangement (HRA) - IRC Sec. 105/106

This is an innovative way to address the rising cost of health care. Facing budget constraints for employee group medical insurance, it may be time to consider an old insurance concept, a high deductible health plan (HDHP), with a new tax advantaged benefit design. A Health Reimbursement Arrangement (HRA) allows an employer to designate a specific amount of funds for each participating employee to use to pay for health care expenses. All employer contributions to the plan are tax deductible as a business expense and are treated as tax free to the employee. What makes the HRA even more attractive is that unused funds may be rolled over, at the employer's discretion, into the next plan year.

With the adoption of a HDHP, an HRA will benefit the employer by an immediate reduction in the insurance premium. The premium savings can be used to offset the employer's contribution to the employees' HRA accounts. Subject to the benefit design, an HRA can result in significant savings. Because the premium for the risk component in a HDHP is lower than that of a traditional PPO, the rate adjustment at renewal will be on a lower premium basis.

As with any purchase, participating employees tend to make more discretionary decisions about health care spending when spending their own money. The higher utilization patterns encouraged by first dollar benefits common in a traditional Preferred Provider Option (PPO) are reduced. More cost-conscious claiming translates into more manageable rate actions.

For the employee, the benefit design can be quite flexible. In addition to medical expenses, dental, vision and prescription drug expenses may also be reimbursed from the member's savings account. The employee saves as well. Payroll deductions based on a lower fixed cost will be less. At the employer's discretion, unused funds from the health reimbursement account may roll over into the next plan year. Tax-free interest may be paid on account balances.

Because this is a qualified plan, a Plan Document is required. A funding arrangement must be established in order to reimburse participant claims.

Tax Treatment – Fringe benefits extended to partners or 2% or more shareholders in an S Corp are considered partners for fringe benefit taxation purposes. The cost to provide the benefit to partners is treated as guaranteed payments . The cost of the benefits is treated as a tax-deductible compensation expense to the partnership or the S Corp. and reported as taxable compensation income to the partner or the 2% or more S Corp. owner In the case of a C Corp., fringe benefits can be provided tax-free to shareholder-employee and are tax deductible.

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