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Can A Company’s Owners Participate In Its HRA?


Question: Our company would like to establish a Health Reimbursement Account (HRA) when we switch to higher deductible health coverage. Will our owners be able to participate in that HRA?

Answer: The answer depends on several factors, including how your company is organized and the amount of the company owned by each working owner. Tax-free benefits under an HRA can be provided only to:

  • Current and former employees (including retirees), and their spouses,
  • Covered tax dependents, and
  • Children who haven’t attained age 27 by the end of the tax year.

Owners who are “self-employed individuals” within the meaning of Internal Revenue Code (IRC) Section 401(c) aren’t considered employees for this purpose and may not participate in an HRA on a tax-favored basis.

Defining the self-employed

Generally, a self-employed individual is someone who has net earnings from self-employment as defined in IRC Section 1402(a), accounting only for earnings from a trade or business in which the “personal services of the taxpayer are a material income-producing factor.” Ineligible owners include partners, sole proprietors and more-than-2% shareholders in an S corporation. Stock ownership by employees of a C corporation doesn’t preclude their tax-favored HRA participation.

The ownership attribution rules in IRC Section 318 apply when determining who’s a more-than-2% shareholder of an S corporation, so any employee who’s the spouse, child, parent or grandparent of a more-than-2% shareholder of an S corporation would also be unable to participate in the S corporation’s HRA on a tax-favored basis. A disqualified individual (whether because of direct or attributed ownership) could, however, be the beneficiary of a qualifying participant’s HRA coverage if they’re the qualifying participant’s spouse, tax dependent or child under age 27.

Although the IRS hasn’t clearly addressed whether self-employed individuals may participate in an HRA if the company treats the HRA coverage as a taxable benefit, informal IRS comments suggest that participation on a taxable basis isn’t allowed (even though the IRS has permitted such participation for non-tax-dependent domestic partners).

HRAs vs. HSAs

Although self-employed individuals can’t participate in HRAs, they can have Health Savings Accounts (HSAs). However, they can’t receive tax-free contributions to their HSAs through a cafeteria plan. This relative advantage for HSAs has led some employers to favor HSA programs over HRAs.

But HRAs have other advantages for employers, including more control over how amounts are spent and typically lower costs relative to the STET amount of benefits provided. (While the full HSA contribution must be funded with cash, HRAs typically are notional accounts that need only be funded when participants incur expenses, and not all participants will incur expenses up to the limit established by the employer.) Thus, the decision will seldom be made based on the participation rules alone.


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