2004 Lane Reports

Deduct Most Medical Care Costs with a Self-Insured Medical Plan

Saturday, May 1, 2004

There's an enormous new tax opportunity employers ought to know about. It's called a "Healthcare Reimbursement Arrangement," or an "HRA," and it's an exciting - - and terrifically tax-advantaged - - self-insured medical reimbursement plan.

A self-insured medical reimbursement plan reimburses employees for "qualified health care expenses." Qualified health care expenses are those generally defined as expenses related to any illness, long-term care services and health insurance. Reimbursements are not taxed as income except for routine diagnostic procedures performed on the covered employee. However, routine diagnostic procedures for dependents reimbursed under a self-insured medical reimbursement plan are excluded from employees' income.

A self-insured medical reimbursement plan must cover all employees of the organization and it may not be discriminatory. If the plan discriminates in favor of highly-compensated employees, then a portion of the reimbursements to these employees is included in their gross income. The nondiscrimination rules for self-insured medical reimbursement plans are the same rules that apply to all welfare benefit plans, so the plan must cover a majority of an organization's employees to avoid the income tax on reimbursements to highly-compensated individuals, who are usually the owners and their family members employed by the business.

Most businesses which adopt self-insured medical plans supplemented by health care insurance essentially eliminate their owners' 7.5% medical expense itemized deduction threshold because the business pays all of the owner's health care costs. Almost all a business owner's health care expenses are deductible as business expenses without a corresponding increase in income.

What's new and different about an HRA is that it provides employees an annual defined benefit amount of health care reimbursements. The defined amount limits the amount of reimbursements available on a yearly basis, as opposed to typical self-insured medical reimbursement plans which have no limits on reimbursements.

Health care reimbursements under an HRA may not only be excluded from the income of current employees, but also former employees, including retired employees, their spouses and dependents and the spouses and dependents of deceased employees. However, self-employed individuals are not considered employees under the rules for an HRA. And reimbursements may continue even if the employee does not elect COBRA continuation coverage.

Employers may create HRAs that are flexible and, if they want to, even provide separate benefits for former employees. The employer may elect to reimburse a former employee up to his or her unused reimbursed amount, or an employer may establish an HRA to provide for an increase in the amount available for reimbursement of health care expenses. In addition, an HRA may be drafted to reduce any post-employment reimbursements by the administrative costs of continuing coverage, similar to COBRA.

Although HRAs make good sense for many employers, they do render the employer liable to every employee up to the maximum reimbursable amount each year, and possibly even a higher amount if the HRA has a rollover provision. And HRAs are subject to the nondiscrimination rules applicable to all welfare benefit plans.

Recent legal developments make self-insured medical reimbursement plans - - and HRAs - - even better.

" The first is the exclusion of income for reimbursements for over-the-counter drugs from health care reimbursement plans. To be excluded from an employee's income, nonprescription drugs must be purchased for an illness or injury, and the new law does not consider dietary supplements to be nonprescription drugs. And, as in the past, under the itemized medical expenses deduction, over-the-counter or nonprescription drugs are not deductible. This is an additional incentive to both the business and its employees to adopt a self-insured medical reimbursement plan.

" A same-gender domestic partner may be considered a dependent for health care benefit purposes. This means that health care coverage provided by an employer for an employee's same-gender domestic partner is now excluded from the employee's gross income and wages.

" Effective for all plan years starting in 2004, self-insured medical reimbursement plans may use debit or credit cards to reimburse plan participants. The convenience of issuing a credit card to pay for the employees' health care costs of a business is an additional service health care insurers or providers are likely to begin offering their clients.

Self-insured medical reimbursement plans - - and, especially, HRAs - - offer a tax-deductible way to fund most of a business owner's health care costs while providing an extremely valuable benefit to the business' employees. But the choices can be complicated. A cost-benefit analysis should be completed to determine what kind of a self-insured medical reimbursement plan would benefit the business owner the most.

We'll be happy to help you decide whether such a plan makes sense for your business and, if it does, we'll be happy to assist you in designing and implementing just the right plan for you.


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The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2007 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.

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