Small Businesses Can Reimburse Employees for Health Costs

Small businesses can reimburse employees for certain health insurance and other medical costs using a Qualified Small Employer Health Reimbursement Arrangement (QSEHRA).

Many small employers don't want to purchase comprehensive group health insurance for their employees because of the expense, but they do want to provide some health benefits. In the past, small employers often reimbursed their employees for some of their health care costs. Provided that certain requirements were satisfied, these reimbursements were tax free to the employees and tax deductible by their employers—a win-win for everyone. However, the Affordable Care Act (ACA) eliminated most such health reimbursement arrangements by subjecting employers who offered them to large penalties. Fortunately, such arrangements are making a comeback.

The 21st Century Cures Act, which took effect in 2017, allows small employers to offer Qualified Small Employer Health Reimbursement Arrangements (QSEHRAs) to their employees without facing ACA penalties. Under these plans, an eligible small business can reimburse an employee's individually purchased health insurance and other deductible medical costs of up to $5,150 per year for an individual and up to $10,450 for a family (these limits are for 2019). The cost of the QSEHRA benefit must be entirely covered by the employer.

Which Employers May Offer QSEHRAs?

QSEHRAs may be offered only by employers with fewer than 50 full-time (or full-time equivalent) employees during the prior year and employers who do not offer a group health plan to any of their employees. Employers with more than 50 full-time employees are required by ACA to provide their employees with minimum health insurance coverage or face stiff penalties.

Which Employees May be Covered by QSEHRAs?

Only employees who obtain their own health insurance that meets the minimum requirements of ACA (called "minimum essential coverage") may benefit from a QSEHRA. Reimbursements paid to an employee without this coverage must be included in the employee's taxable income. Minimum essential coverage includes all individually purchased private insurance, government insurance such as Medicare, and the employee's or spouse's job-based insurance. The employees must provide their employer with proof that they have such coverage.

All eligible employees must be covered by the QSEHRA. This includes all employees except those who:

  • have not completed 90 days of service
  • are under age 25
  • are part-time or seasonal employees
  • are covered by a collective bargaining agreement if health benefits were the subject of good faith bargaining, or
  • are nonresident aliens with no earned income from sources within the United States.

Thus, QSEHRA benefits cannot be offered to only a select group, such as to only a company's owner and top level employees.

A QSEHRA plan may be used only for employees. It can not be used by sole proprietors, partners in partnerships, or members of limited liability companies (LLCs). These individuals do not qualify as employees for QSEHRA purposes. However, until the IRS issues further guidance, a business organized as an S corporation may maintain a QSHRA for its shareholder-employees, even if they own more than 2% of the corporate stock.

How to Establish a QSEHRA

The employer begins a QSEHRA by giving all of its eligible employees written notice of the plan, which can also serve as the document establishing the plan. The notice must be given 90 days before the beginning of a plan year. The notice must:

  • list the amount of the employee's permitted benefit for the year
  • require the employee to provide information about the QSEHRA to any health insurance exchange to which the employee applies for advance payment of premium assistance tax credits to help pay for health insurance, and
  • contain a warning that, if the employee is not covered under minimum essential coverage for any month, the employee may have to pay tax on any plan reimbursements.

An employer that fails to provide the required notice may be subject to a $50 per-employee, per-failure penalty, up to a $2,500 calendar year maximum for all such failures.

What Expenses May Be Reimbursed?

One of the great things about QSEHRAs is that they can be used to reimburse employees for a wide variety of health-related expenses. Indeed, deductible medical expenses include any expense for the diagnosis, cure, mitigation, treatment, or prevention of disease, or any expense paid to affect the structure or function of the human body. This includes, of course, premiums in health and accident insurance and health insurance deductibles and co-payments. But it also includes expenses for acupuncture, chiropractors, eyeglasses and contact lenses, dental treatment, laser eye surgery, psychiatric care, and treatment for learning disabilities. It includes prescription medications, but not nonprescription medications.

Reimbursement Procedures

Employees should submit written requests for reimbursement of their covered medical expenses. The employer should pay the reimbursement only after receiving proof from the employee that he or she has minimum essential coverage—this should pose no problem for most employees. Such reimbursements must be funded solely by the eligible employer—that is, no salary reduction contributions may be made under the QSEHRA. Any unused reimbursement amounts may be rolled over to be used in future yeas.

The employer must report the total reimbursements made during the year on the employee's Form W-2. However, if the requirements covered above are satisfied, these will be tax free to the employee, and tax deductible by the employer.

Employees Who Receive Health Insurance Premium Assistance

Many employees of small businesses who obtain their own health insurance coverage through the ACA health exchanges qualify for a health insurance premium tax credit. These credits are paid to individuals whose household incomes do not exceed 400% of the federal poverty level. The QSEHRA rules prohibit these employees from "double-dipping" their benefits. The rules require that the tax credit must be reduced by the amount of any employer reimbursements under a QSEHRA. This is handled by the healthcare exchanges. Employers do not have to make any adjustments for the no double-dipping rule other than to mention it in the plan document.

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