8805 / What is a health reimbursement arrangement (HRA) and how is it taxed?

The IRS defines an HRA as an arrangement that:

(1)  is solely employer-funded and not paid for directly or indirectly by salary reduction contributions under a cafeteria plan; and

(2)  reimburses employees for substantiated medical care expenses incurred by the employee and the employee’s spouse and dependents, as defined in IRC Section 152, up to a maximum dollar amount per coverage period.

A taxpayer is entitled to carry forward any unused amounts in the individual’s account to increase the maximum reimbursement amount in subsequent coverage periods.¹ HRAs are not available for self-employed individuals.

Employer-provided coverage and medical care reimbursement amounts under an HRA are excludable from an employee’s gross income under IRC Section 106 and IRC Section 105(b), assuming all requirements for HRAs are met.²

Reimbursements for medicine are limited to doctor-prescribed drugs and insulin for tax years beginning after December 31, 2010. Beginning in 2020, the CARES Act permanently removed this restriction so that a prescription is no longer required.³

An HRA is not permitted to offer cash-outs at any time, even on an employee’s termination of service or retirement. However, it may continue to reimburse former employees for medical care expenses after such events even if the employee does not elect COBRA continuation coverage.⁴ An HRA is a group health plan and, thus, is subject to COBRA continuation coverage requirements.

HRAs once could, on a one-time basis per HRA, make a qualified HSA distribution. A qualified HSA distribution is a rollover made before January 1, 2012 to a health savings account (see Q 8825), of an amount not exceeding the balance in the HRA as it existed on September 21, 2006.⁵

HRAs may not be used to reimburse expenses that were either incurred before the HRA was in existence or that are deductible under IRC Section 213 for a prior taxable year. An unreimbursed claim incurred in one coverage period may be reimbursed in a later coverage period, so long as the individual was covered under the HRA when the claim was incurred.⁶

The IRS has approved the use of employer-issued debit and credit cards to pay for medical expenses as incurred provided that the employer requires subsequent substantiation of the expenses or has in place sufficient procedures to substantiate the payments at the time of purchase.⁷

In 2020, the IRS proposed regulations on direct primary care arrangements and their treatment for HRA purposes. Direct primary care arrangements are more commonly known as “concierge care,” where an individual and a medical professional enter a contract to cover the cost of medical care for a fee (without the involvement of a traditional third-party insurance company). Under the regulations, a direct primary care arrangement could be used for medical care or medical insurance. This would make these payments eligible expenses for purposes of the Section 213 medical expense deduction. They could also be reimbursed from an HRA if the regulations are finalized.⁸