How HRAs Can Reduce Your Tax Liability

Health Reimbursement Arrangements (HRAs) offer a unique opportunity for both employers and employees to reduce their tax liability. By allowing employers to reimburse employees for qualified healthcare expenses tax-free, HRAs provide a powerful tax-saving tool that benefits everyone involved. Whether you’re an employer looking to cut down on payroll taxes or an employee seeking to maximize healthcare benefits without added tax burden, HRAs can help.

This guide will walk you through the specifics of how HRA tax deduction can minimize tax liability, provide financial planning advantages, and offer flexibility in healthcare benefits for both sides.

Learn how to save on taxes with HRAs by working with Take Command today.

Table of Contents

• What is a Health Reimbursement Arrangement (HRA)?
• Types of HRAs
• HRA vs. HSA
• Tax Advantages of HRAs for Employers
• Tax Benefits for Employees
• Eligibility and Participation
• What Can Impact HRA Tax Advantages?
• Choosing the Right HRA for Tax Reductions
• Conclusion: How Take Command Can Help

HRA Tax Benefits

Health Reimbursement Arrangements (HRAs) are employer-sponsored plans that allow businesses to reimburse employees for healthcare expenses in a tax-advantaged way. These plans provide significant tax benefits for both employers and employees, as reimbursements are generally tax-free, and employer contributions are often deductible as a business expense. This makes HRAs a powerful tool for reducing tax liability while providing valuable healthcare benefits.

In this article, we will explore the tax-saving potential of HRAs and compare them to other health benefit options like Health Savings Accounts (HSAs). You will also gain insights into how small businesses can effectively implement HRAs to maximize tax advantages.

In this article, you will learn:

• How HRAs offer substantial tax savings for employers.
• Key tax benefits for employees using HRAs.
• Best HRA strategies for small businesses to reduce tax liability.

What Is a Health Reimbursement Arrangement (HRA)?

A Health Reimbursement Arrangement (HRA) is an employer-funded plan designed to reimburse employees for qualified medical expenses. Unlike other health benefits, HRAs allow businesses to set aside a fixed amount of money each year for employees to use toward out-of-pocket healthcare costs, such as medical services, prescriptions, and even health insurance premiums.

HRAs are flexible and customizable, meaning employers can design the plan to fit their company’s budget and healthcare needs. Importantly, the reimbursements employees receive through an HRA are typically tax-free, making this a valuable benefit for both employees and employers looking to reduce their tax liabilities.

Is HRA taxable? Employers don’t pay payroll taxes on contributions to HRAs, and employees don’t have to pay income or payroll taxes on the money they receive, making it a win-win for both parties. HRAs are a great tool for businesses of any size to offer comprehensive health benefits without the financial strain of traditional group health plans.

Types of HRAs

HRAs come in different forms, each designed to cater to specific types of businesses and employee needs. Below, we’ll explore the most common types of HRAs and how they offer unique tax benefits and flexibility and the HRA tax benefits. 

ICHRA (Individual Coverage HRA)

The Individual Coverage HRA (ICHRA) is one of the most flexible and scalable HRA options available. Designed to allow employers to reimburse employees for individual health insurance premiums and medical expenses, ICHRA gives employers more control over costs. Employees can select their own individual health plans and get reimbursed for qualified expenses, making it highly customizable.

From a tax perspective, ICHRA offers significant advantages. Employer contributions are tax-deductible, while employees receive the reimbursements tax-free, helping both parties save money. The flexibility of ICHRA also makes it scalable, allowing businesses of all sizes to use it effectively.

QSEHRA (Qualified Small Employer HRA)

The Qualified Small Employer HRA (QSEHRA) is tailored for small businesses with fewer than 50 employees. It allows these businesses to offer health reimbursement benefits without the complexity and costs of traditional group health plans. Employers can reimburse employees for individual health insurance premiums and qualified medical expenses.

For small businesses, QSEHRAs offer a significant tax benefit: contributions are tax-deductible, and employees do not pay taxes on the reimbursements. This makes it an ideal choice for businesses looking to provide health benefits while reducing their overall tax burden.

GCHRA (Group Coverage HRA)

The Group Coverage HRA (GCHRA) is designed to work alongside traditional group health insurance plans. It allows employers to supplement their existing health coverage by reimbursing employees for out-of-pocket expenses not covered by their group insurance, such as deductibles or co-pays.

From a tax perspective, GCHRAs are highly beneficial. Employer contributions are tax-deductible, and employees receive reimbursements tax-free. By offering a GCHRA, businesses can enhance their employee benefits package while enjoying predictable, tax-advantaged contributions.

EBHRA (Excepted Benefit HRA)

The Excepted Benefit HRA (EBHRA) is a unique type of HRA that allows employers to provide reimbursements for certain non-insurance medical expenses, like dental, vision, and short-term limited-duration insurance. Unlike other HRAs, EBHRA can be offered alongside traditional group health plans without replacing them.

EBHRA offers tax advantages by allowing employers to contribute up to a set limit (determined annually) without those contributions being considered taxable income for employees. It’s a valuable tool for covering additional health-related expenses while maintaining a tax-efficient strategy.

HRA vs. HSA

While Health Reimbursement Arrangements (HRAs) and Health Savings Accounts (HSAs) are both valuable tools for managing healthcare expenses, they function differently and offer distinct tax benefits. Understanding these differences can help employers and employees choose the option that best fits their financial and healthcare needs.

Employer vs. Employee Contributions

The primary difference between HRAs and HSAs lies in who controls the contributions. HRAs are entirely employer-funded, meaning employees don’t contribute to these accounts. In contrast, HSAs can be funded by both employers and employees, giving employees the option to set aside pre-tax dollars for healthcare expenses.

From a tax perspective, both options provide benefits. HRA tax benefits: HRAs allow employers to deduct contributions as a business expense, while HSA contributions—whether from the employer or employee—are tax-deductible. Employees can also use HSAs to save for future medical expenses, accumulating tax-free growth on contributions.

Flexibility in Usage

HRAs offer flexibility because employers can design the reimbursement plan to cover specific healthcare expenses, including insurance premiums, doctor visits, and other qualified medical expenses. HSAs, on the other hand, are more limited to expenses related to high-deductible health plans (HDHPs) but offer broader long-term savings options.

While HSAs allow employees to carry funds over from year to year, HRAs typically do not. However, employers may allow unused HRA funds to roll over at their discretion, adding another layer of flexibility for businesses.

Tax-Free Withdrawals and Reimbursements

Both HRAs and HSAs allow employees to access funds tax-free for qualified medical expenses. For HSAs, this includes healthcare costs now and in the future, making it a potential retirement savings vehicle for medical expenses. HRAs, however, are more focused on covering immediate healthcare expenses during employment.

Choosing the Right Option

Choosing between an HRA and an HSA depends on the company’s structure and the employee’s healthcare needs. HRAs tend to be a better fit for businesses looking to control costs while offering tax-free benefits. HSAs, by contrast, are advantageous for employees who want to actively save and invest for future healthcare needs while enjoying immediate tax benefits.

Tax Advantages of HRAs for Employers

HRA tax benefits for employers makes them an attractive option for businesses looking to reduce tax liabilities while providing comprehensive healthcare benefits to their employees. Here’s how HRAs provide substantial tax advantages to businesses with HRA tax deduction.

1. Deduct Contributions to HRAs as a Business Expense

One of the primary tax advantages of offering an HRA is that employer contributions to the plan are fully tax-deductible as a business expense. This reduces the company’s taxable income, providing a direct financial benefit to the business. By reimbursing employees for their healthcare expenses, employers can write off these contributions, lowering their overall tax burden.

2. Predictable Costs for Better Financial Planning

HRAs allow businesses to set a fixed contribution amount toward employee healthcare costs, offering better predictability in financial planning. Unlike traditional group health plans with fluctuating premium costs, HRAs give employers control over how much they will contribute each year. This level of control helps businesses manage their budget more effectively while still offering valuable benefits to employees. Plus, these contributions remain tax-deductible, making them a smart financial strategy.

3. Provide Additional Compensation Without Added Payroll Taxes

HRAs allow employers to provide employees with additional compensation in the form of healthcare reimbursements without triggering payroll taxes. Traditional compensation increases would lead to higher payroll taxes for both the employer and employee. However, reimbursements through an HRA are not subject to Social Security, Medicare, or unemployment taxes, creating a more efficient way to boost employee compensation while minimizing the company’s tax liability.

4. Comply with the Affordable Care Act (ACA)

HRAs can help businesses stay compliant with ACA regulations. The introduction of Individual Coverage HRAs (ICHRAs) allows employers to meet ACA requirements for offering health coverage, particularly for companies with 50 or more employees who are required to provide health insurance. By offering an ICHRA, businesses can avoid potential tax penalties associated with ACA non-compliance while taking advantage of tax-deductible contributions.

Tax Benefits for Employees

Health Reimbursement Arrangements (HRAs) are not just a tax-saving tool for employers—employees can also enjoy significant tax advantages. By using an HRA, employees can reduce their tax burden while gaining access to vital healthcare reimbursements. Here are the key ways HRAs benefit employees from a tax perspective:

1. Tax-Free Reimbursements for Qualifying Medical Expenses

One of the biggest tax advantages for employees is that the reimbursements they receive for eligible medical expenses are typically tax-free. This means that employees do not have to pay income taxes, Social Security taxes, or Medicare taxes on the funds reimbursed through their HRA. Eligible expenses can include medical care, prescriptions, insurance premiums, and other healthcare costs, allowing employees to use pre-tax dollars for healthcare, effectively boosting their purchasing power.

2. Expanded Healthcare Coverage

HRAs enable employees to expand their healthcare coverage by reimbursing out-of-pocket costs. Whether it's for individual health insurance premiums, copays, or other medical expenses, employees can access funds tax-free, which allows them to use their salary for other purposes. This expanded coverage offers peace of mind and financial flexibility without increasing their taxable income.

3. No Payroll Taxes on Reimbursements

Unlike traditional compensation, which is subject to payroll taxes (Social Security, Medicare, etc.), reimbursements from an HRA are exempt from these taxes. This means employees can receive additional financial support for healthcare expenses without the burden of payroll tax deductions, increasing the real value of their total compensation package.

4. No Requirement to Pre-Fund Accounts

One of the advantages of HRAs over other health savings vehicles, like Health Savings Accounts (HSAs), is that employees are not required to pre-fund the account themselves. They can simply submit eligible expenses for reimbursement as needed. This means employees don’t have to allocate a portion of their paycheck to healthcare costs in advance, which can help with cash flow and financial planning. Additionally, they can still receive the tax benefits without the need to budget for healthcare savings upfront.

Eligibility and Participation

Not all employers and employees are eligible to participate in Health Reimbursement Arrangements (HRAs), and understanding the requirements is essential for maximizing the tax advantages. This section outlines who qualifies to participate and what medical expenses can be reimbursed under an HRA.

Companies/Employees Who Are Eligible to Participate

Eligibility for HRAs depends on the type of HRA being offered. Here’s an overview of eligibility criteria for different HRAs:

• ICHRA (Individual Coverage HRA): Any employer, regardless of size, can offer an ICHRA. Employees must be enrolled in individual health insurance coverage (or Medicare) to participate. Employers can structure the ICHRA differently for various classes of employees, such as full-time, part-time, or seasonal workers.
• QSEHRA (Qualified Small Employer HRA): Only small businesses with fewer than 50 full-time employees are eligible to offer a QSEHRA. Employees are generally required to have health insurance coverage to receive reimbursements, but the plan is open to all employees, regardless of part-time or seasonal status.
• GCHRA (Group Coverage HRA): Available to employers that offer a group health plan. Only employees enrolled in the group plan are eligible to participate in the GCHRA for the reimbursement of out-of-pocket medical costs.
• EBHRA (Excepted Benefit HRA): This type of HRA can be offered to employees in conjunction with group health plans, but it is used to cover specific non-insurance benefits like dental and vision care. Any employee enrolled in the employer’s group health plan can participate.

Medical Expenses That Can Be Reimbursed

The list of eligible expenses that can be reimbursed through an HRA is defined by the IRS. Typically, qualified medical expenses include those related to the diagnosis, treatment, or prevention of disease. Below are some of the most common expenses that can be reimbursed tax-free:

• Health insurance premiums: Depending on the type of HRA, employees can get reimbursed for the cost of individual health insurance premiums, including plans purchased through the marketplace or Medicare premiums.
• Out-of-pocket medical expenses: These include doctor’s visits, hospital stays, lab tests, surgeries, and preventive care.
• Prescription medications: Employees can be reimbursed for prescription drugs as well as over-the-counter medications if prescribed by a doctor.
• Dental and vision care: Certain HRAs, such as the EBHRA, can reimburse employees for dental and vision expenses, including exams, treatments, and corrective lenses.
• Other medical equipment and supplies: Reimbursements may also cover expenses for durable medical equipment, hearing aids, and other medically necessary items.

Understanding who qualifies and what expenses are eligible ensures that businesses and employees maximize the tax-saving potential of HRAs.

What Can Impact HRA Tax Advantages?

While HRAs offer significant tax advantages, certain factors can influence the extent of those benefits. Understanding these factors is crucial for both employers and employees to ensure they are maximizing the tax-saving potential of their Health Reimbursement Arrangement (HRA). Below are key aspects that can impact the overall tax advantages of an HRA:

1. Type of HRA Contributions

The type of HRA offered by an employer plays a major role in determining the tax benefits. For instance, ICHRA (Individual Coverage HRA) allows employees to purchase individual health insurance and receive reimbursements tax-free. On the other hand, QSEHRA (Qualified Small Employer HRA) has specific contribution limits that employers must follow. Different HRAs have varying levels of flexibility and tax advantages, making it important to choose the right type based on the company’s structure and employees' healthcare needs.

2. Employer Contribution Amounts

The amount an employer contributes to the HRA can directly affect the tax benefits. In most cases, employer contributions to an HRA are tax-deductible as a business expense, which reduces the company’s taxable income. However, contribution limits vary depending on the type of HRA, such as QSEHRA’s annual contribution caps. It’s important for businesses to ensure they are within IRS guidelines to maximize their tax deductions while providing adequate benefits to employees.

3. IRS Regulations

IRS regulations set the rules for how HRAs must operate to qualify for tax benefits. For example, employers must adhere to contribution limits, maintain proper documentation, and ensure that reimbursements are only used for qualified medical expenses. Failing to comply with IRS guidelines can result in the loss of tax deductions for the employer and could make employee reimbursements taxable. Staying up-to-date with IRS rules is essential to avoid any tax penalties.

4. Employee Tax Brackets

The tax benefits employees experience from HRAs can be influenced by their individual tax brackets. Since reimbursements are tax-free, employees in higher tax brackets stand to benefit more, as they avoid paying taxes on money that would otherwise be subject to income tax. This makes HRAs particularly valuable for high-earning employees who can offset significant healthcare expenses tax-free.

5. State Tax Laws

While HRAs offer federal tax advantages, state tax laws can vary. In some states, HRA contributions may still be subject to state taxes, reducing the overall tax benefits. It’s important for both employers and employees to understand their state’s specific tax regulations when using an HRA to avoid surprises during tax season.

6. Documentation Requirements

Proper documentation is key to maintaining the tax-exempt status of HRA contributions and reimbursements. Employers need to keep detailed records of all contributions, eligible expenses, and reimbursements made to employees. Employees must submit proof of qualifying medical expenses to receive tax-free reimbursements. Inadequate documentation can lead to issues during tax filing, and the IRS may disqualify certain reimbursements, making them taxable.

Choosing the Right HRA for Greatest Tax Liability Reductions

Selecting the right type of Health Reimbursement Arrangement (HRA) is essential for maximizing tax savings for both employers and employees. The different types of HRAs—such as ICHRA, QSEHRA, GCHRA, and EBHRA—offer varying tax advantages depending on the specific needs and structure of the business. This section will help you determine which HRA might be the best fit to provide the most significant tax liability reductions.

1. Evaluate Business Size and Structure

The size of your business and the way it is structured plays a crucial role in selecting the right HRA:

• Small Businesses (Fewer than 50 Employees): If you operate a small business, a QSEHRA may be the best option. This HRA is specifically designed for businesses with fewer than 50 employees, offering tax-free reimbursements for individual health insurance premiums and qualified medical expenses. Employers benefit from tax-deductible contributions, while employees receive tax-free reimbursements.
• Businesses of Any Size: For businesses of any size, the ICHRA provides a highly customizable solution. This type of HRA allows employers to reimburse employees for individual health insurance premiums and out-of-pocket expenses while maintaining control over costs. ICHRAs are particularly advantageous for companies with diverse workforces, as they allow employers to set different contribution amounts for different classes of employees.

2. Align with Employee Needs

Understanding the healthcare needs of your employees can help you determine which HRA will maximize their tax savings:

• For Employees Needing Flexible Health Insurance Options: An ICHRA may be ideal, as it allows employees to choose their own health insurance plan, which the employer can then reimburse. This flexibility, combined with tax-free reimbursements, gives employees more control over their healthcare while providing significant tax savings.
• For Employees Seeking to Cover Out-of-Pocket Costs: A GCHRA could be the right choice if your company already offers a group health plan. GCHRAs are used to cover additional healthcare costs, such as deductibles or copays, providing employees with more comprehensive coverage while keeping reimbursements tax-free.

3. Maximize Tax Deductions for Employers

Employers looking to reduce their own tax liabilities should consider the structure of their HRA contributions:

• Tax-Deductible Contributions: All HRAs allow employers to deduct their contributions as a business expense, but the flexibility of certain HRAs, like ICHRA and QSEHRA, may provide more control over how much is contributed and when, offering more predictable tax savings.
• Avoid Payroll Taxes: By reimbursing employees through an HRA rather than increasing wages, employers can provide financial support for healthcare without increasing payroll taxes. This method of offering compensation provides a tax-efficient way to support employees without the added tax burden of traditional salary increases.

4. Stay Compliant with Regulations

Choosing the right HRA also means understanding compliance with IRS and ACA regulations:

• ICHRA for ACA Compliance: Businesses with 50 or more employees that are required to offer health insurance can use an ICHRA to comply with the Affordable Care Act’s (ACA) employer mandate. By offering an ICHRA, these businesses avoid potential penalties while benefiting from tax-deductible contributions.
• QSEHRA for Simplicity: For smaller employers, QSEHRAs offer a simpler and more streamlined option with fewer regulatory requirements, making it easier to stay compliant while offering valuable tax-free benefits to employees.

By evaluating your business’s size, employee needs, and regulatory obligations, you can select the HRA that provides the greatest tax liability reductions for both your company and your workforce.

Are HRA Contributions Tax Deductible?

Yes, HRA contributions are tax-deductible for employers. Here's how it works:

• For Employers: The contributions made by employers to employees’ HRAs are considered a business expense, which makes them tax-deductible. This is a major financial advantage for businesses, as they can offer healthcare benefits while reducing their overall tax liability.
• For Employees: Employees receive HRA reimbursements tax-free for qualified medical expenses and health insurance premiums, meaning they do not have to report these reimbursements as taxable income. This makes HRAs an effective, tax-efficient way to manage healthcare costs for both parties.

HRAs thus offer a win-win by providing tax benefits for both employers and employees while ensuring healthcare costs are covered in a flexible and cost-effective way.

Conclusion: How Take Command Can Help

Health Reimbursement Arrangements (HRAs) are a powerful tool for reducing tax liabilities for both employers and employees. By selecting the right type of HRA, businesses can offer valuable health benefits while taking advantage of tax deductions, predictable costs, and avoiding payroll taxes. Employees, on the other hand, enjoy tax-free reimbursements for their healthcare expenses, expanding their coverage without the added tax burden.

In this guide, we’ve explored how HRAs, such as ICHRA, QSEHRA, GCHRA, and EBHRA, can provide significant tax savings and how the right choice depends on your business size, employee needs, and regulatory obligations.

At Take Command, we specialize in helping businesses navigate the complexities of HRAs. Whether you're a small business looking to offer cost-effective health benefits or a larger company seeking ACA compliance, we can guide you to the best solution. Our experts are here to ensure you get the maximum tax benefits while supporting your employees' healthcare needs.

Contact Take Command today to discover how we can help you implement the right HRA strategy and start saving on taxes.