Q: Our company offers a Health Reimbursement Arrangement (HRA), which is designed to help employees pay a good portion of medical expenses that they would otherwise have to pay out-of-pocket. Several years ago, we learned that as an S Corporation, we are prohibited from contributing to an HRA for employees who have at least a 2% ownership in the company (and their family members who work here).
Our former accountant had advised that we could continue contributing to the HRA for 2% owners (and their family members) as long as the contributions were treated as taxable income to them. We were able to make this change with the company that administers our HRA. We just got a new accountant, who is telling us that we cannot contribute to HRAs for 2% owners and their family members at all, even with after-tax dollars. His problem seems to be with the fact that the same HRA administrator manages both the employees’ and the owners’ HRAs, making it in effect a single HRA in which the owners are incorrectly participating. Can you clarify?
A: While I cannot provide tax or legal advice, I tend to agree with your former accountant. After reviewing your HRA plan document/summary plan description, I found it specifically excludes 2% owners from participating in the HRA on a pre-tax basis. That, combined with the fact you are taxing any reimbursements made to owners through the HRA, should be sufficient to establish that the owners are merely benefiting from an informal reimbursement arrangement, which is allowed. The fact that the same company is administering both the company’s untaxed contributions to employee HRAs and taxed contributions to owner HRAs shouldn’t matter.
I do recommend that, since you have two tax professionals in disagreement with each other, you confirm this with your benefits attorney.
For more about the restrictions on pre-tax benefits for S corporation owners, see this previous Question of the Month.