S Corporations Save Thousands of Tax Dollars With HRA

S Corporations utilizing Section 105 HRA are saving thousands of additional tax dollars on medical spending


Many S Corporations today are only able to deduct 100% of their family’s health insurance premiums on the 1040, which includes federal and state tax savings.  However, some S Corps have found additional tax savings by establishing a Section 105 Health Reimbursement Arrangement. 

 

HRA savings are a result of FICA tax savings each pay period based on medical expenses incurred during that period, as well as additional FICA tax savings each quarter, since the corporation will not have to pay matching FICA tax for the medical expenses incurred.  However, shareholder-employees should continue taking the standard self-employment health insurance premium tax deduction on their 1040 (if applicable) while using the HRA.

 

The IRS requires you to have a formal written plan (HRA) in order to receive these savings. HRAs are considered non-discriminatory plans and therefore must also be offered to any qualified non-shareholder.  Because of the compliance issues surrounding HRAs, tax professionals rely on benefit administrators such as BASE® to handle these types of plans. 

 

How Does It Work?

The following example will take you step-by-step through an S Corporation scenario where the business has established a Section 105 HRA.  This particular S Corporation has the business salary set at $36,000, health insurance premiums are $500 per month, and out-of-pocket is roughly $250 per month.

 

Step 1

Shareholders must receive W-2 compensation (formal payroll) in order to achieve tax savings using an HRA.  The business starts by restructuring the $36,000 salary to include family health expenses.  The monthly salary will stay the same ($3,000), and is still subject to federal and state income tax.  The FICA tax is now calculated on $2,250 rather than $3,000 ($3,000-$500 HIP-$250 OOP=$2,250), increasing take home pay by $57.38 per month.

 

Step 2

The business must change the way they report income on the quarterly 941.  Previously, the business owner would have reported $9,000 as subject to Social Security and Medicare tax.  With an HRA in place it is now $6,750, reducing Social Security and Medicare tax.  This will result in the business not having to match Social Security/Medicare Taxes.

 

HRA savings are a result of FICA tax savings each pay period based on medical expenses incurred during that period, as well as additional FICA tax savings each quarter, since the corporation will not have to pay matching FICA tax for the medical expenses incurred.

 

Step 3

The business reports the total $36,000 W-2 income received by the shareholder on line 7 of the 1120S.

 

Step 4

The business must also adjust the W-2.  The HRA allows shareholder-employees to replace a portion of their existing W-2 income with an employee benefit that is not subject to Social Security/Medicare tax (FICA).  Box 1 remains the same as in previous years ($36,000).  Boxes 3 and 5, however, are reduced ($27,000).  The business will also report the $9,000 HRA employee benefit in Box 14, as other income, to verify to the IRS that the $9,000 is not subject to FICA/FUTA tax.

 

Many self-employed business owners, including S Corporation Shareholders, utilize an administrator like BASE® to go beyond the 1040 deduction with a Section 105 HRA.  Each scenario is different and deductions may vary based on your business size and plan design.  An HRA allows small business owners to save on their federal, state and self-employment taxes by taking the deduction on their business tax return. 

 

BASE® ensures that small business owners are properly deducting medical expenses with a formally written plan in order to stay in compliance with regulatory agencies such as the IRS, DOL and ERISA.  Currently the Departments are planning to publish future guidance on the application of the market reforms to a 2-percent shareholder-employee healthcare arrangement.  Until such guidance is issued, and in any event through the end of 2015, the excise tax under Code section 4980 will not be applied for any failure to satisfy the market reforms by a 2-percent shareholder employee healthcare arrangement.


Anne Case
BASE® - Director of Marketing & Communications

Can I Pre-Tax Individually Owned Health Insurance Through a 125 Cafeteria Plan?

2013 introduced debate and controversy surrounding Employer Payment Plans. Notice 2013-54 was released and addressed Health Reimbursement Arrangements, Section 125 Plans including both the premium component and Flexible Spending Accounts and ultimately created a definition of Employer Payment Plans. All of these terms were tossed around in this guidance which really emphasized individual health insurance and the relation to Employer Payment Plans.

Notice 2013-54 defines an Employer Payment Plan as anytime “an employer reimburses an employee’s substantiated premiums for non-employer sponsored hospital and medical insurance, the payment are excluded from the employee’s gross income under Code Section 106. The exclusion also applies if the employer pays the premiums direction to the insurance company.”. The only exclusion to this rule is for plans that have only one qualified participant.

The guidance released left many in the industry wondering if a Section 125 Plan is an Employer Payment Plan. An Employer Payment Plan is the practice of an employer paying for or allowing an employee to have their individual health insurance excluded from income under Code Section 106(a). Since the salary reductions are exempt from taxes they are regulated under Notice 2013-54. Furthermore, Code Section 125 causes all salary reductions to be considered employer contributions for tax purposes, thereby allowing the coverage to be funded in a tax-advantaged manner.

According to Treasury Regulation Section 1.125-1(r)(2) “Salary reduction contributions are employer contributions. An employee’s salary reduction election is an election to receive a contribution by the employer in lieu of salary or other compensation that is not currently available to the employee as of the effective date of the election and that does not subsequently become currently available to the employee.”

But what does all of this mean?

- 125 Plan elections or salary reductions are considered employer payments

- Any pre-tax contributions to individual health are considered to be paid for by the employer which creates an Employer Payment Plan

- Notice 2013-54 does not allow an employer to pay for individual health coverage with more than 1 participant

- Allowing pre-tax elections for individual health insurance makes employer subject to the $36,500 excise tax per employee per year established under Section 4980D

This may leave you wondering if this is simply BASE’s stance, but the industry has resoundingly been saying NO to pre-tax health insurance since the beginning of 2014. Employers cannot provide any type of pretax options for individual insurance plans. Furthermore according to Department of Labor FAQ Part XXII released on November 6, 2014 an employer cannot tax or give employees stipulated income to pay for individual premiums. Additionally an employer cannot require proof of payment or proof of coverage before the employee can obtain taxable income. The only legal way for an employer to pay for some or all of their employees’ insurance coverage is to obtain a group insurance plan.

Anne Case
BASE® - Director of Marketing & Communications

Proposed Bill Could Change HRA Restrictions For Small Group Employers

A new bipartisan bill has been introduced to Congress pertaining to small businesses wanting to offer a stand-alone HRA (Heath Reimbursement Arrangement).  U.S. Rep. Mike Thompson (D-CA) and Congressman Charles W. Boustany, Jr.(R-LA) introduced the Small Business Healthcare Relief Act of 2014 to a congressional committee last December. Though the bill has a way to go, it would greatly benefit small business employers (49 or fewer employees) and their employees.


Back on September 13, 2013 the Department of Labor and Internal Revenue Service issued guidance disallowing businesses from using a stand-alone HRA to help employees pay for individual health insurance premiums on a tax-free basis. By moving this bill into law, it would alter those previous regulations while still building on the reforms made in the Affordable Care Act.


Under the Small Business Healthcare Relief Act of 2014 small employers could:


- Use pre-tax dollars to give workers a defined contribution

- Allow employees to use those pre-tax funds in an HRA to purchase healthcare coverage on the individual market and for qualified out-of-pocket medical expenses

- Avoid financial penalties for providing these types of funds to employees


While we all wait to see if the bill will gain any traction, we encourage you to contact your local Representative about H.R. 5860 – Small Business Healthcare Relief Act of 2014 and support the allowance of small businesses using pre-tax dollars for assistance to employees purchasing polices in the individual market.


Remember to keep BASE® in mind for your tax advantaged benefit plan needs. Call 1-800-309-8012 if you have any questions.


Tom Stiles
BASE® - Digital Marketing Assistant