HRA Funding

[nancy]

Can an employer fund his entire HRA commitment in one year and deduct it? Or must he only deduct when the expenses are incurred?

[Ron Snyder]

The employer can fund and deduct the current year service cost plus a 90-day reserve under IRC 419. In addition, the employer can fund and deduct in the same year an additional amount under Section 419A up to the account limit provided. It may require an actuarial calculation/certification to obtain a significant deduction.

[GBurns]

Why would an HRA be subject to 419 limits. There is neither a Trust or a separate Fund etc. It is entirely an accounting entry as are most other 105 MERPS, which is all that an HRA is plus the rollover feature.

[Ron Snyder]

You answered your own question: because of the rollover feature. A bookkeeping entry would not be deductible, but an HRA for current contributions to provide future medical benefits can be deducted within the limits provided under 419A.

[Don Levit]

I understand an HRA to be considered unfunded, even if specific funds are set aside. Deductions are not available until medical expenses are actually incurred.

Why are you mentioning section 419, VEBAGURU?

That section refers to multiple employer plans with trusts set up for current year's and future years' funding.

Why would an employer prefund an HRA into a trust, if the deduction was not available, until the expense was incurred?

Don Levit

[GBurns]

The setting aside for or pre-funding of an HRA is not subject to 419. The funding of an HRA is not subject to any 90 day limit or account limits.

[Ron Snyder]

Don L-

Your understanding that an HRA is considered unfunded even if it is funded is incorrect. I don't know what you mean by "set aside", but amounts added to a "qualified asset account" are tax-deductible within the limitations provided in IRC section 419A.

IRC sections 419 and 419A impose tax deduction limitations on ALL welfare benefit plans, not "multiple employer plans" as you aver.

The employer would prefund an HRA into a trust because the deduction IS available.

G Burns-

You are correct that "The setting aside for or pre-funding of an HRA is not subject to 419." However, the set aside/carryover portion is subject to 419A limitations.

[Don Levit]

I am involved on another chat group sponsored by the Galen Institute. All the HRA "experts" spoke of the HRA being a notional account, of which no specific funds are set aside.

Today, I read a paper on the CCH web site which stated, "Unless the HRA is unfunded, that is, the benefits are paid out of the general assets of the employer, the funds become plan assets subject to ERISA and must be held in trust, pursuant to a written trust instrument, with an annual independent audit requirement."

If accurate, this statement leads me to beloeve that HRAs can be funded, or unfunded. If funded, the deduction is available. If paid out of general assets, no dduction is available until the expense is actually paid.

VEBAGURU, I read over sections 419 and 419A, and saw nothing about a 3-month reserve.

Can you point out where that may be in those sections?

Don Levit

[Ron Snyder]

Notational accounts is the most common approach to HRAs. However your initial post posited a funded approach.

Of course such assets are subject to ERISA. The audit requirement may or may not apply, as with retirement plans.

The rule of thumb is that medical claims that are incurred and unpaid as of the end of the year will be approximately equal to 3 months of claims. However, the safe harbor limitation provided in IRC 419A©(5)(B)(ii) is a more liberal 35%, so it is possible to exceed the 3-month reserve at least once. (In subsequent years the calculation is the new 35% less the prior 35% plus claims incurred.)

[GBurns]

Again, What does this have to do with HRAs?

[Don Levit]

This discussion has nothing to do with HRAs. Assuming a trust is set up for a funded HRA, the deductions are limited to current year's expenses.

You cannot prefund future years' medical expenses with an HRA.

You can do so with a VEBA, as I am sure both GBurns and VEBAGURU are aware.

When VEBAGURU wrote that current contributions for future medical benefits are deductible under 419A, he was correct for certain situations, such as a 10 or more employer trust.

This cannot be done with an HRA trust, however.

Don Levit

[GBurns]

The topic is "HRA Funding"., so I do not understand why you would post that "This discussion has nothing to do with HRAs".

If "You cannot prefund future years' medical expenses with an HRA" then what would be the purpose of allowing rollovers? Rollovers are to be used to pay expenses. At time of rollover those expenses have not yet have been incurred. So the rollover is a "set aside" for expenses to be incurred. "To be incurred" is synonymous to "future expenses". "Set aside" is is synonymous to "prefund". As a logical result the rollover prefunds future medical expenses. What have I misunderstood?

419 is applicable to VEBAs and would only be applicable if an HRA "Trust" was a VEBA, but vebaguru might have some reason why he thinks otherwise.

[Don Levit]

GBurns:

I agree with everything you said. However, the general rule for deductibility is that the medical expense must be incurred. With the HRA, we have a unique situation with the carryover provision.

The original question, way back at the top, had to do with deducting the HRA contributions at the beginning of the year (even if not all of that year's contribution was used for medical expenses).

Where in the HRA regulation, or in the Internal Revenue Code, is a current deduction allowed for future medical expenses (as it applies to this situation, not retiree health plans, etc.).

Don Levit

[GBurns]

The original post said nothing about "deducting the HRA contributions at the beginning of the year " which would have been impossible and is never done anyhow.

Business expense deductions are not taken at time of expense (or contribution in this case) nor taken at the start of the year. They are taken whenever the business does its tax return for that period.

The deduction of business expenses are a function of section 162. It is not subject to HRA regulations in the same way that an employer's payment of employee health insurance is a deduction allowed under section 162 not 105, 106 or 125.

A business that funds the employee's HRA accounts with an up front lump sum at the start of each year is entitled to take the full deduction of that amount on the tax return for that year if the money cannot revert to the employer and even in that case that is questionable. The money is no longer the employer's and so becomes a business expense in the full amount.

The employer's expense has no relationship to the incurring of medical expenses. It is the employee's use of the money that is conditioned by incurring medical expenses.

When the employee chooses to use it or leave employment and take it etc etc is no concern as far as the business expense is concerned.

[Don Levit]

GBurns make an interesting case here for deduction as a business expense versus a medical expense.

I can see how the IRS could view this either way.

If the IRS considered this a medical expense, how would they view the deductibility of the carryovers?

Would this deductibility depend on whether the employee is vested or not?

Don Levit

[GBurns]

I think that you are confusing the reimburseing of medical expenses incurred by an employee which is a function of HRAs with the deduction of expenses by an employer. These are 2 separate issues.

The funding of an HRA by an employer is a business expense (what he classifies it as on his books is irrelevant to this issue, it might very well be lumped with insurance premiums and called Employee Health Benefits Expense Account). The reimbursing of an employee from an HRA requires a medical expense.

It is possible that vesting could be an issue, but that would depend on the specifics of the plan design.

[Don Levit]

GBurns:

Vesting is definitely an issue, as regards to the carryovers. I see the carryovers as very similar to deferred compensation. Deferred compensation, generally, is deductible only when the benefits are paid, not when they are funded. Without vesting, I do not see the benefits as irrevocably available to the employee; therefore, it is not deductible.

Don Levit