HRAs Correlating With Cafeteria Plan Salary Reductions

[Guest texastax]

Will pre-tax salary reduction under a cafeteria plan be deemed to indirectly fund an HRA where premium payment for the health plans sponsored the employer only permit after-tax contributions to the extent of the monthly HRA contribution (i.e., the HRA participant does not have a choice of using HRA contributions in lieu of pre-tax salary reduction contributions). Also, what are the practical penalties if the HRA is recharacterized as an arrangement that does not meet the definition of an HRA? Would this only entail income tax inclusion to the participants and wittholding obligations on the employer? Thanks for your thoughts.

[g8r]

I don't understand the facts that you have.

However, you raise a good question - what happens if you fail to meet the HRA requirements?

The worst case scenerio would be an inclusion in income and all applicable payroll taxes. The employer would still get a deduction b/c it's compensation.

[GBurns]

The employer should also face penalties for underwithholding and mis-reporting as part of the withholding obligations.

[Guest texastax]

Thanks. I agree with both of your assessments as to the penalties. As for my question dealing with the ability of using an HRA to pay premiums of an employer-sponsored group health plan (when pre-tax salary reductions could also be used to pay the same premium under a cafeteria plan), the following example is provided in IRS Notice 2002-45:

"[A]ssume an employer provides a reimbursement arrangement in conjunction with another accident or health plan. Employees participating in the reimbursement arrangement are reimbursed up to $1,000 each year for substantiated § 213(d) medical care expenses and unused amounts remaining at the end of the year are carried forward for reimbursements in later years. The employee-share of the annual premium for the other accident or health plan is $1,500. Employees have a choice either to use amounts in the reimbursement arrangement to pay for the premium for the other accident or health plan or to pay that premium pursuant to a salary reduction election. Under this plan, the reimbursement arrangement does not reimburse any portion of the premium paid by salary reduction. Because an employee may use the reimbursement arrangement to pay a portion of the premium in lieu of electing to salary reduce, the reimbursement arrangement is indirectly funded pursuant to salary reduction. This arrangement does not meet the definition of an HRA because it is funded by salary reduction and it is subject to the rules under § 125."

Therefore, to prevent this deemed funding of the purported HRA by salary reduction while still allowing for a portion of the premiums to be paid by the HRA, should the cafeteria plan be amended to disallow salary reduction for purposes of each employer-sponsored health plan premium that could be paid by the HRA to the extent of the monthly HRA employer contribution (and the HRA be amended to allow for premium payments up to a maximum amount for each such plan to prevent an overlap with salary reductions)? Such an arrangement would then not permit the employee to have a choice between paying a portion of the premiums with pre-tax dollars and HRA dollars, since the pre-tax dollars option would be taken away. Again, thanks for any thoughts.