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Tax Strategies to Save On our Health Care Costs

Tax Strategies to Save On our Health Care Costs

With skyrocketing health care costs plaguing many small businesses, the search is on for a plan that will give financial relief. Most business owners recognize the importance of health insurance for themselves and their employees, but costs are forcing more and more to drop group health plans. Health Reimbursement Arrangements ("HRA") and Health Savings Accounts ("HSA") can help businesses and individuals to save money in two ways: health insurance premium savings, additional write offs for medical expenses, and tax savings. Some people hesitate in making a change to a HRA or HSA, but consider the following:

HRA Plan (Health Reimbursement Arrangement)
An HRA is an employer-funded health reimbursement plan, without any salary reduction or a high deductible health plan, that reimburses employees for qualified medical expenses. The HRA is structured under Internal Revenue Code Section 105 and has been utilized by taxpayers since 1954. The main reason we as taxpayers have not heard about these plans is because insurance companies don't make money off an HRA plan and tax planners aren't motivated to educate their clients about their benefits.

Because the HRA is funded completely by the employer, there is a great deal of flexibility in how the employer designs the plan. Certain medical costs can be restricted from reimbursement or some funds may not roll over from year to year, depending on the design. Benefits must be extended to all qualifying employees. Key characteristics of an HRA plan include:
  • Money is completely employer funded, no employee money can be contributed. Salary reductions or flex credits are not required.
  • Reimburses qualified (section 213(d)) medical expenses, over the counter drug expenses, some health insurance premium costs, COBRA premiums, and individual plan premiums on a limited basis.
  • Can be a stand alone-plan.
  • Can be implemented inside any entity type (i.e. C-corps, S-corps, LLCs, or Sole Proprietorships). However, if you are a more than 2% shareholder of an S-corp or member of the LLC, you will have to consider the use of a C-corp or Sole-proprietorship in order to utilize the HRA


The tax benefits extend to both company and employee. The money contributed to the HRA by the company is tax deductible. Additional benefits beyond a simple health plan may therefore be offered without the burden of paying payroll taxes and related expenses.

For the employee, money used from the HRA amounts to tax free income. Unlike an IRA which is tax deductible initially but is taxed upon withdrawal, the employee never pays tax on HRA money because it is paid to the employee spent on medical expenses without ever incurring taxes.

HSA Plan (Health Savings Account)
The HSA was created recently by federal legislation. A HSA lets you set aside pre-tax dollars for future medical retirement, or long-term care premium expenses. Invest these funds as you wish within a broad range of choices, then use them for qualified medical expenses. The funds can roll over from year to year and your employee can take them with them when they change jobs. They are principally designed to reimburse an individual or family for out-of-pocket healthcare expenses, and not as a retirement tool. However HSA plans work differently than HRA plans in regards to contributions. HSAs are more like 401(k) plans in that employees contribute tax deductible funds which are then matched by the employee. This gives an employee the ability to receive a greater benefit if the needs are greater, and reduces the employer's responsibility as they contribute only if the employee does first. Key characteristics of the HSA include:
  • Funded by employer and employee
  • Must be used in conjunction with a high deductible health plan.
  • The account is portable and funds stay with the employee upon termination.
  • Can be invested in mutual fund-like accounts for potential growth.
  • At age 65, unused funds may be used for any purpose.
  • Employer has less flexibility in defining the use of the funds.
  • Unused funds roll over from year to year.


Both the HSA and HRA plans have their advantages and disadvantages in regards to the needs of employees and employers. The decision on which plan to use should be made carefully, and with help from an qualified tax advisor, as well as one who understands insurance plans.

One of the major considerations in deciding if an HSA plan fits your business, is understanding that to have a HSA you must be enrolled in a qualified High Deductible Health Plan ("HDHP"). Federal legislation creating HSAs defines a high deductible health plan as having a minimum annual deductible of $1,000 for a self-only plan, or a $2,000 for a family plan. The theory of the HDHP is that the taxpayer pays a lesser monthly premium payment and uses the savings to invest in the HSA account. The hope is that the taxpayer will save on actual out of pocket medical costs on an annual basis and accumulate the savings. Remember, we are talking about a assuming a financial risk that the insurance company has deemed acceptable. We can accept this risk ourselves and save the profit and administrative costs the insurance company would normally keep. Is there a risk? Yes, but the risk is limited. With a higher deductible, one might pay more if there are significant health issues in the family. But even with a higher deductible plan, there are out-of-pocket maximums that one would pay.

Summary
Each plan works differently and has unique features, but both are designed to make out-of-pocket expenses tax-deductible and taxpayers can save through the additional tax writes offs that may have only been deductible at best as an itemized deduction. See the comparison chart below for a more detailed comparison. The HRA and HSA plans can make all expenses deductible, saving people hundreds or possibly thousands of dollars per year. In the near future, we will be adding additional information on our website regarding the strategy used to implement an HRA plan, links to HSA sponsors and the downloadable documents to implement an HRA plan NOW!



The chart below explains some differences between an HRA and an HSA. It also shows the advantages and disadvantages of each plan in different circumstances. We hope that this will give you a better understanding of the differences between an HRA and an HSA.





Health Reimbursement Arrangement
(HRA) 		Health Savings Account
(HSA)
Overview An Employer funded benefit plan, without any salary reduction, that reimburses employees for qualified medical expenses.
Advantage: The HRA was created in 1954 and over the last 50 years has been thoroughly reviewed, clarified and tested.
 A savings account created in conjunction with a High Deductible Health Plan ("HDHP") to pay for qualified medical expenses.
Disadvantage:The HSA was created in late 2003 and many clarifications are still pending.
Eligibility Any employee that satisfies the employer established non-discrimination rules under Internal Revenue Code ("IRC") Section 105(h).
Advantage: The HRA does not require a HDHP.
 Any individual covered under a qualifying HDHP and not qualifying for Medicare, or covered under another non-qualifying health plan may participate in the plan.
Health Plan Requirements None.
Advantage: The HRA will work with any Health Insurance policy, regardless or deductible amounts and out of pocket maximums.
 Must have a qualifying HDHP.
For individual coverage an annual deductible no less than $1000 with a maximum annual out of pocket limit of no more than $5000.
For family coverage an annual deductible no less than $2000 with an annual out of pocket limit of no more than $10,000.
Funding Employer funded.
Advantage: Employer controls benefit dollar amounts of the HRA.
 Employer and/or employee funded.
Contribution Limits Unlimited*.
*Within Plan Parameters.
 100% of the deductible or $2600/$5150, whichever is less.
Disadvantage: The HSA is restricted to a maximum funding of $2600/$5150 (individual/family) per year.
Tax Treatment Employer: Deducted by the employer.
Employee: Non-taxable to the employee.
Advantage: HRA is 100% deductible from a federal, state, and self-employment taxes standpoint.
 Employer: Employer portion is non-taxable to the employee and deductible by the employer.
Employee: Employee funding is typically a post-tax contribution and deductible as a personal expense on the 1040.
Non-Discrimination Requirements Subject to non-discrimination requirements under IRC Section 105(h).
Advantage: With an HRA, the employer has the ability to exclude certain employees (i.
e.
Part time, Age, Length or service).
 Employer must make "comparable" contributions for all employees.
Allowed Benefits Reimbursement of qualified health insurance premiums and medical expenses under IRC 213 (including OTC drugs).
Advantage: Health Insurance premiums are also deductible with the HRA.
 Reimbursement of qualified medical expenses under IRC 213 (including OTC drugs).
No health insurance premiums.
Carry Over and Investment Unused funds may be carried forward to subsequent years.
However, they can not be invested to earn income.
 Unused funds may be carried forward to subsequent years.
Advantage: HSA funds may be invested and earn interest non-taxable.
Administration Generally self-administered.
Advantage: With the HRA, funds are not transferred to/from a third party (i.
e.
Bank, insurance company, etc.
).
 Funds held by qualifying trustee (i.
e.
Bank, insurance company, etc.
), directed by individual.
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