For many small businesses, it’s simply not economically or administratively feasible to offer group health insurance to employees, which can create a competitive disadvantage for business owners trying to attract top talent that needs health coverage. The good news of the launch of state health insurance exchanges under the Affordable Care Act was that, for the first time, individuals had guaranteed access to health insurance regardless of employment status, eliminating the need or requirement for employers to provide coverage. The bad news, however, was that to avoid disrupting the existing employer group health insurance marketplace, the Affordable Care Act imposed penalties on businesses if they tried to simply give employees tax-preferenced reimbursements to buy their own coverage on the exchanges.
However, the 21st Century Cures Act, signed by President Obama shortly before leaving office, created a new Qualified Small Employer Health Reimbursement Arrangement (QSEHRA), which allows small businesses with fewer than 50 full time equivalent employees to offer an HRA for employees to purchase their own health insurance on a tax-preferenced basis – tax-deductible to the employer and tax-free to the employee – without running afoul of the ACA coverage mandates. Although employees cannot “double dip” and obtain premium assistance tax credits and employer HRA dollars, it is now possible for employers to give a specified tax-preferenced dollar amount reimbursement to employees – up to $5,050 for individuals and $10,250 for couples and families in 2018 – for their medical expenses, including health insurance premiums for coverage purchase on an exchange.
The primary appeal of the QSEHRA for most small business owners is that it’s a way to provide employee “health benefits”, without taking on the full burden – and cost uncertainties – of offering group health insurance. Instead, employers can control their costs by explicitly setting a monthly dollar amount that becomes available to employees for reimbursement, avoiding payroll taxes on any dollars actually spent, and keeping any unused QSEHRA dollars that aren’t actually claimed by employees as a reimbursement (since technically an HRA is a health reimbursement arrangement, not an actual account).
Notably, the QSEHRA benefits are not available for most small business owners themselves, though with the above-the-line deduction for health insurance premiums for small business owners, the QSEHRA would often be a moot point anyway. Nonetheless, for small business owners looking to do “something” to support employee health benefits, and have better control over their business and costs than offering group health insurance directly (or joining a PEO), a QSEHRA may be a very appealing tax-preferenced alternative!
How The Affordable Care Act Limited Health Reimbursement Arrangement (HRAs)
A key change to health insurance under the Affordable Care Act was the requirement that all group health insurance plans offer various “Essential Benefits” – including emergency services and hospitalizations, pregnancy and maternity and newborn care, mental health and substance abuse disorders, lab services, and prescription drugs – in addition to covering certain preventive health services at no cost, and no lifetime limits on coverage. The changes were meant to ensure that, no matter what health insurance plan someone purchased, he/she could be confident that all the typical “essential” benefits that might be expected would be included.
The caveat of the new requirement that group health plans cover Essential Benefits, though, was that the new rules applied to all types of group health plans, including not only group health insurance itself, but also employer Health Reimbursement Arrangements (HRAs) and Health Flexible Spending Accounts (FSAs), which allowed employers and/or employees to set aside dollars for their future medical expenses (or in some cases, to simply purchase their own health insurance coverage). Yet a limited dollar set-aside to reimbursement employee medical expenses would inevitably fail to cover all of the Essential Health benefits and no-cost preventative services, and consequently IRS Notice 2013-54 declared that most HRAs and FSAs would not satisfy the ACA requirements, potentially subjecting employers to penalties under IRC Section 4980D of as much as $100 per day per employee for failing to provide the required coverage.
The situation was particularly vexing for many small businesses, that didn’t and couldn’t afford to offer group health insurance to all employees, and suddenly found themselves unable to even offer a partial employee health benefit in the form of an HRA that would allow employees to take the dollars and simply purchase their own health insurance of choice on an individual exchange. Instead, small business employers were either required to either upgrade to a full health insurance plan (which might be supplemented by an HRA), or just eliminate the HRA benefit altogether (which might be “made up” with a higher salary, but that in turn had less favorable tax treatment for both the employer and employee!).
21st Century Cures Act Introduces The Qualified Small Employer Health Reimbursement Arrangement (QSEHRA)
On December 13th of 2016, President Obama signed into law H.R. 34, also known as the 21st Century Cures Act. The primary focus of the legislation was to boost funding for medical research and enact Federal policy reforms on mental health care. But included in Section 18001 of the legislation was a provision to establish a new “Qualified Small Business Health Reimbursement Arrangement” (or QSEHRA for short), that became effective for 2017.
Under the new IRC Section 9831(d), eligible small businesses would be permitted to establish a Health Reimbursement Arrangement (HRA) without running afoul of the group health plan requirements under the Affordable Care Act. In order to qualify, the HRA must be fully funded by the employer (i.e., it is not a salary deferral or employee contributory account, it is an employer “arrangement”), and must cover bona fide and documented medical expenses as defined in IRC Section 213(d) (which includes both medical care, and health insurance) for the employee and/or the employee’s family members. In addition, the employer themselves must have fewer than 50 full-time-equivalent employees (where “full-time” is working 30+ hours per week) to be an “eligible” small business (and not be an “Applicable Large Employer”, or ALE, under IRC Section 4980H(c)(2)).
As with any Health Reimbursement Arrangement (and similar to health insurance coverage itself), contributions to the HRA are tax-deductible for the employer (and not subject to FICA payroll taxes), and payments (i.e., reimbursements) are received tax-free by the employee. However, with a QSEHRA, in order for the employee to receive reimbursements tax-free, he/she must be covered by a health insurance plan that provides the ACA-mandated Essential Health Benefits. Notably, there’s no requirement for QSEHRA dollars to be used for health insurance premiums – it might be used for deductibles, copays, or other medical expenses – but for any reimbursement to be tax-free, the employee must have health insurance (and provide proof of coverage to the employer at the time of enrollment to affirm this). If the employee does not have the requisite health insurance coverage, payments into the HRA are still deductible for the employer, but will be taxable income to the employee when received (akin to a normal taxable salary or bonus payment). On the other hand, if qualifying health insurance coverage is also a High-Deductible Health Plan, the employee can still make HSA contributions to pay for medical expenses even though he/she is participating in the HRA and may be using those dollars to pay the health insurance premiums.
Annual contributions to a QSEHRA were originally limited to $4,950 for individuals, and $10,000 for families, but are annually increased for inflation (rising to $5,050 and $10,250, respectively, in 2018, under Revenue Procedure 2017-58). In addition, contribution formulas must be set on similar terms for all employees, whether as a dollar amount (e.g., $300/month) or a percentage (e.g., 50% of health insurance premiums). Though it is permissible to vary the dollar amounts based on family status (e.g., $300/month for individuals, and $500/month for families), age, or employee status (e.g., part-time vs full-time). In addition, employees can be excluded if they are seasonal, part-time, have been working at the company for fewer than 90 days, are under age 25, or are covered under a union (with a collective bargaining agreement).
Premium Assistance Tax Credits And QSEHRA Reporting
Notably, if an employee ultimately obtains health insurance from an individual exchange and is eligible for a premium assistance tax credit, the individual must report to the exchange that he/she is a participant in a QSEHRA, and the amount of the tax subsidy is reduced by the available QSEHRA benefit. Of course, to the extent that the individual receives the QSEHRA benefit in lieu of the tax subsidy, the net cost of coverage is the same for an employee – for instance, if the cost of coverage is $3,000/year, the premium assistance tax credit is $2,000/year, but the individual is eligible for a $2,000 QSEHRA, the net cost of coverage is still $3,000 - $2,000 = $1,000, it’s just that the $2,000 difference is covered by the employer rather than a government tax credit. This effectively ensures that individuals do not “double dip” into receiving tax-preferenced QSEHRA benefits and a premium assistance tax credit to cover the same health insurance premiums (regardless of whether he/she actually uses the QSEHRA to pay the premiums).
For reporting purposes, QSEHRA benefits will be reportable on Form W-2 (likely with a new reporting code to be developed), and via a soon-to-be-updated version of Form 1095-B. Employers must also provide notification to employees, both upfront to indicate the amount of QSEHRA benefits, that benefits will be taxable if employees don’t obtain health insurance that meets the “Minimum Essentials Coverage” (MEC) requirements, and that employees must notify their insurance exchange of the QSEHRA if they apply for a premium assistance tax credit (to ensure the HRA benefits are coordinated with the tax subsidy). Employers must also obtain proof of insurance coverage from employees (to affirm the HRA benefits will be tax-free), and must allow employees to join either when joining the employer, during an annual open enrollment, or after a qualifying life event (QLE).
Because a QSEHRA is only available to W-2 employees, though, it is not available to sole proprietorships (who cannot pay themselves salaries), partners or LLC members (who receive partnership profits or guaranteed payments but not salary), or more-than-2% S corporation owners. However, salaried owner-employees of C corporations are eligible, as are less-than-2% S corporation owners. In addition, an employee spouse of a partnership, LLC, or sole proprietor owner may be eligible to participate in a QSEHRA, for which an owner can access the HRA benefits as the eligible-employee’s spouse.
The Benefits Of Utilizing A QSEHRA
The benefit of the QSEHRA is that employers can provide tax-preferenced dollars to employees for health insurance, but without actually needing to contract with an insurer to offer the insurance itself. Instead, the employer gets the equivalent tax benefits of paying for health insurance, but allows employees to make their own decision about which health insurance policy to buy (and/or whether to use the dollars for other medical expense reimbursements instead). And because the employee buys their own health insurance policy through an insurance exchange, that means they own their coverage, which naturally makes it portable if the employee decides to leave and change employers (rather than being forced to rely on COBRA coverage, a new employer’s plan, or try to buy a new health insurance policy in the midst of a job change).
In addition to avoiding the need to get an actual group health insurance contract – which can be challenging and time-consuming for some small businesses, and especially difficult for those with virtual employees across multiple states that don’t want to roll up under a PEO – the employer also gets clearer control of their contribution for employee health costs, by being able to set a fixed dollar amount that will be contributed to the HRA every month of the year. For many small businesses, this will be more appealing than paying for health insurance directly (or a set percentage of health insurance premiums for employees), which means the employer doesn’t even know what their health insurance costs will be until they get their own premium increase notification for the following year. (Although for employers that want to set the HRA benefits as a percentage of health insurance premiums, that is an available way to set terms for the HRA contribution amount.)
An added benefit is that, since the QSEHRA is ultimately based on a reimbursement arrangement – not an actual account – the dollars that an employer sets aside for the HRA revert back to the employer if they’re not actually used. Thus, to the extent not all employees end out using their HRA allocations on actual medical expenses or health insurance during the year, the money reverts back to the employer to use (although if the employee doesn’t use/receive the dollars, the employer doesn’t end up with their tax deduction, either).
Of course, there is a cost to set up a QSEHRA – as most small businesses will likely want to outsource to a third-party QSEHRA administrator, so the firm doesn’t have to directly implement processes and procedures to fulfill employee notification requirements, obtain proof of insurance coverage for employees (to affirm reimbursements will be tax-free), verify documentation of medical expenses before making reimbursements payments, etc. Yet with pricing in the neighborhood of $15 - $25 per month per employee from companies like Zane Benefits and Take Command Health, most employers will be able to cover the cost of administering the plan with the payroll tax savings of offering it. After all, $400/month paid to employees through a QSEHRA instead of just paying it as salary to let employees purchase their own health insurance coverage saves 7.65% x $400 = $30.60/month in taxes anyway.
Perhaps the biggest caveat to the QSEHRA is simply that employees are still responsible for getting their own health insurance coverage, ostensibly through the health insurance exchanges, but in a world where the cost, availability, and quality of coverage on the exchanges does vary from one state to the next. As a result, not all employees may be happy with the coverage choices they have on their state insurance exchange that they are using their QSEHRA dollars to purchase. Though on the other hand, if the employer couldn’t afford or wasn’t able to arrange group health insurance coverage anyway, employers may still argue that providing tax-preferenced dollars through the HRA is better than nothing.
Winding Down A Group Health Insurance Plan To Implement A QSEHRA
And employers in states with a robust state insurance exchange may prefer to wind down their group health insurance plan and just offer QSEHRA dollars for employees to purchase their own coverage instead. Although notably, the wind-down of existing coverage must be closely coordinated with the launch of the QSEHRA, since a requirement of the QSEHRA is to not be offering health insurance coverage at the same time. Employers should be cautious not to cause employees to have coverage gaps during the transition. Though fortunately, the loss of employer coverage associated with the shift from group health insurance to a QSEHRA is itself a Qualifying Life Event that would make the employee eligible to purchase new coverage on the state insurance exchange (even outside of the annual open enrollment period).
In fact, arguably a lot of small business employers may prefer to wind down their existing group health insurance, and just allow employees to purchase their own coverage on exchanges instead, subsidized by a QSEHRA that may offer employees the same dollar amount of premium assistance, but give them more coverage choices (at least on most exchanges), more flexibility (e.g., to use the QSEHRA for other medical expenses if a spouse already has employer coverage of their own for the family), and allow them better portability (as the employee can keep the policy bought from the exchange even if there’s a future job change). Which is actually why the QSEHRA is limited to “small businesses” (under 50 full-time equivalent employees) in the first place; because a key aspect of the Affordable Care Act, as originally written, was to not disrupt the large employer group health insurance marketplace by making it too easy for large firms to eliminate health insurance coverage and drive employees to the exchanges instead. However, for small businesses that don’t have the bargaining power of large employers for group health insurance coverage, the QSEHRA may be more appealing (and less disruptive to the employer health insurance marketplace).
Perhaps the greatest perceived drawback to the QSEHRA for many small business owners considering it is simply that the business owners themselves cannot participate. Although notably, while sole proprietors, partners of partnerships (and members of LLCs taxed as partnerships), and more-than-2% S corporation owners cannot receive dollars via a QSEHRA, they can already receive an above-the-line deduction for health insurance premiums paid, which would generally make the QSEHRA a moot point for business owners themselves anyway. And as discussed earlier, business owners who are sole proprietors or partners of partnerships (or members of LLCs taxed as partnerships) may still be able to participate in a QSEHRA – e.g., for additional medical expenses beyond their health insurance premiums themselves – if there is a spouse who is a bona fide W-2 employee of the business and participating in the QSEHRA.
The bottom line, though, is simply that for small businesses who want to offer some means for employees to obtain (their own) health insurance coverage on a tax-preferenced basis, the QSEHRA provides an appealing alternative to those employers that don’t want to (or can’t manage to) offer an entire group health insurance plan, especially for those that are struggling with (or afraid of) the risk of providing partial or full reimbursement of premiums for a group health insurance plan that gets more expensive every year in a way the employer cannot control.
Instead, with a QSEHRA, small business employers can set a target reimbursement level for health insurance premiums (and/or other medical expenses), allow employees to choose their own (more portable) coverage, and control the costs by deciding as the employer when and whether to increase the HRA allocation – knowing that unused reimbursement dollars will revert back to the small business owner, and that most or all of the administrative costs will likely be covered by the payroll tax savings along the way!
So what do you think? Does the QSEHRA provide new planning opportunities? Is it an attractive alternative to providing a group plan? Will you use a QSEHRA within your own practice? Please share your thoughts in the comments below!