1. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company1 An HRA is an arrangement provided by an employer (including professional corporations) –To reimburse one or more employees (and covered dependents) for medical expenses, such as dental or cosmetic surgery, not covered under a medical plan available to all employees The objective is to provide benefits on a tax-free basis to the employee A second objective is to make such payments tax deductible by the employer What Is A Health Reimbursement Arrangement (HRA)?

2. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company2 An HRA is used –As a substitute for health insurance –As a supplement to provide payments for medical expenses not covered under the company’s health insurance plan –To pay medical expenses in excess of limits in the company’s health insurance plan What Is A Health Reimbursement Arrangement (HRA)?

3. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company3 Where a corporation is closely-held and family members are the primary or only employees –An HRA makes otherwise nondeductible medical expenses deductible In a professional corporation, where the only employee is a professional in a high income tax bracket, or where there are few other employees with relatively smaller salaries –An HRA makes otherwise nondeductible medical expenses deductible When Is Use Of An HRA Appropriate?

4. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company4 Where an employer would like to provide significant tax-favored benefits to employees beyond those provided by the basic medical coverage already in force When Is Use Of An HRA Appropriate?

5. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company5 Must be nondiscriminatory as to both coverage and operation –If a plan is found to be discriminatory reimbursements to highly compensated employees will be included in their income rank and file employees will remain entitled to the income tax exclusion What Are The Requirements?

6. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company6 As to “coverage,” a plan must benefit 70% or more of all employees –Alternatively, if 70% of all employees are eligible to be covered, 80% of those individuals must in fact participate in coverage –As a third alternative, IRS will determine on a case-by-case basis What Are The Requirements?

7. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company7 “Highly compensated employees” are defined for discrimination purposes as –The five highest paid officers –Shareholders holding more than 10% of the outstanding stock value of the corporation –The highest paid 25% of all employees What Are The Requirements?

8. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company8 What Are The Requirements? If the plan discriminates in “coverage”, a fraction of payments received will be includable in income: Amount reimbursed to Payment all participating highlyreceived by any compensated given highly employees Xcompensated Total amountemployee reimbursed to all employees under the plan

9. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company9 A plan would be considered discriminatory in “operation” if –Highly compensated employees are eligible to receive greater benefits than other employees –“Dollar-for-dollar rule,” not based on a percentage or proportion of discrimination rule –Applicable to eligible benefits, rather than amounts actually paid If a plan discriminates in “operation” –The recipient highly compensated employee will have to include the entire amount of excess reimbursement actually received in income, whether or not coverage requirements are met What Are The Requirements?

10. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company10 Example 1: –Corporation maintains a self insured reimbursement arrangement covering all of its employees Plan limits maximum benefits for officers at $5,000 and $1,000 for all other participants –During the plan year, one of the five highest paid officers received reimbursements in the amount of $3,000 Since the same amount of benefits for highly compensated individuals is not provided for all other participants, the plan is deemed discriminatory in “operation” The excess reimbursement the officer received would be includable in his gross income How Is It Done?

11. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company11 Example 2: –Corporation maintains a self insured reimbursement arrangement covering all of its employees Benefits subject to reimbursement are the same for all plan participants Of 100 employees in the company, only 10 are eligible to participate The plan discriminates as to “coverage” How Is It Done?

12. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company12 Example 2 (cont’d): –During the plan year, a highly compensated individual accrued medical expenses in the amount of $4,500 which were reimbursed to him under the plan During the plan year the corporation’s medical plan paid $50,000 in benefits $30,000 of the payments were to highly compensated individuals The amount of excess reimbursement that will be included in the highly compensated employee’s income is ($30,000 / $50,000) x $4,500 = $2,700 How Is It Done?

13. Health Reimbursement Arrangement Chapter 54 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company13 No significant difference exists with regard to the application of the rules regarding an HRA in community property states Issues In Community Property States