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Robin D.
Robin D., Senior Tax Advisor 4
Category: Tax
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Experience:  15years with H & R Block. Divisional leader, Instructor
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As an emoloyee benefit program, instead of having group insurance

Resolved Question:

As an emoloyee benefit program, instead of having group insurance provided to the employees, our company reimburses health insurance premiums and/or out of pocket medical expenses of employees up to a pre-determined annual maximum amount.

I would like to verify that these reimbursed amounts are not considered as taxable income to the emplyees.
Submitted: 2 years ago.
Category: Tax
Expert:  Robin D. replied 2 years ago.

Robin D :

Hello and thank you for using Just Answer,


Under IRC sections 105 and 106, employer-provided health benefits, including reimbursement and insurance, are generally excluded from the income of employees. This applies to any employer-paid system, whether the benefit is provided directly (i.e., through self-insurance) to employees or through an insurance provider or a trust. However, if the plan discriminates in favor of highly compensated employees, the amounts paid to those employees are subject to Federal income tax.


IRC § 105(h)
If you would like the IRS guide on benefits, here is a link
http://www.irs.gov/pub/irs-tege/fringe_benefit_fslg.pdf

Customer:

Thank you for your precise response.


Can benefit amounts differ between SIngle, Married, and Married with Family employees without having negative tax consequences?

Robin D :

As long as the plan does not discriminate based on higher compensatred employees being favored over others, the plan would be fine.

Robin D :

  • compensatred* sorry compensated

Customer:

THank you again. THat answers my queston completely.

Robin D :

Glad to assist

Robin D., Senior Tax Advisor 4
Category: Tax
Satisfied Customers: 7869
Experience: 15years with H & R Block. Divisional leader, Instructor
Robin D. and 7 other Tax Specialists are ready to help you
Customer: replied 2 years ago.


Dear Robin,


 


Some follow up questions if I may:


 


1. If the annual maximum amount is not used up by the employee within a calendar year, the remaining amounts will be carried over to the following years, and if the employee terminates employment the company will pay off the employee (minus 5% to allow for adminstrative fee and corporate payroll tax) along with other severance payments (e.g. accrued vacation) minus income tax deductions.


 


Do you see anything wrong with this procedure from TAX perspective?


 


2. If the employee elects to take the HELTH CARE ALLOWANCE option instead of the REIMBURSEMENT option, we will add the allowance amount (which is 10% lower than the maxmimum reimbursement amount) to his regular monthly salary., with proper deductions.


 


Do you see anything wrong with this option given to the employee?


 


 

Expert:  Robin D. replied 2 years ago.

In number 1 it would make the pay off taxable like the severance.

In number 2 employee would have the tax deduction on their tax return providing they use Schedule A to itemize their deductions.
The amounts that can be excluded from wages are the employer's contributions. If the allowance for health care is deducted from the wages of the employee pretaxed they are still taxable for FICA, if this is like a health savings plan that the employee can choose to be in as opposed to a reimbursement.

Robin D., Senior Tax Advisor 4
Category: Tax
Satisfied Customers: 7869
Experience: 15years with H & R Block. Divisional leader, Instructor
Robin D. and 7 other Tax Specialists are ready to help you
Expert:  Robin D. replied 2 years ago.
Thank you
Customer: replied 1 year ago.

Dear Robin,


 


I understand now that the health benefit program that we had been talking about is called HRA (Health Reimbursement Arrangement) allowed by IRS. Since one of the requirement is to write up a PLAN DOCUMENT, I have been reading up on its regulations.


 


Under IRS publication 969, it specifically states, "YOUR EMPLOYER IS NOT PERMITTED TO REFUND ANY PART OF THE BALANCE TO YOU".


 


It sounds like the rule we established of making the balance of the account as part of severance payment at termination of employment is against that regulation.


 


On the other hand, I believe that the employer has the right to pay off any kind of severance pay.


 


Since the employer can establish the rule to forfeit the balance of the account, can we not establish the rule to forfeit the balance, and on the other hand pay off a severance pay based on the balance figure of the account?


 


If we can not, then it puts me in a bind.


 


regards,


 


Jeff Kamachi


 


 


 

Expert:  Robin D. replied 1 year ago.
Hello again,
You should make the rule that the balance is nonrefundable. Your severance arrangement would need to meet the requirements under different governing agencies.
Section 2510.3-2(b)(1) of the Labor regulations under ERISA provides that an arrangement providing for "severance benefits on account of" termination of employment will not be treated as a pension plan if (i) the payments are not contingent, directly or indirectly, on the employee's retirement, (ii) the total payments do not exceed twice annual compensation, and (iii) the payments are generally completed within two years of termination of employment. Apart from the three specific requirements, the regulation is limited to plans that pay "severance benefits on account of termination of employment..." The one case to address this issue concluded, in fact, that this regulation has no applicability to a plan that unconditionally provides benefits upon termination of employment. See, Lima Surgical Associates, Inc, v. United StatesXXXXX 674, 686-687 (1990), aff'd, 944 F.2d 885 (Fed. Cir. 1991)

Under such a plan, termination of employment may mark the time when the deferred compensation is paid, rather than the event that gives rise to the employer's payment obligation. The plan merely defers
compensation to the point in time when the participant terminates employment, whether voluntarily or involuntarily. There is no contingency that is normally associated with severance pay plans. The participants get their money no matter what the reason for terminating employment, even though it may be limited to two times the annual compensation of the participant and be paid out within two years
time. Wording is everything in your severance agreement.
Customer: replied 1 year ago.

Robin,


 


I understand that there is a difference between "severance agreement payment" and payment at the time of termination no matter what.


 


So are you saying that we should treat this rule as "deferred compensation" for any type of termination? Can we not pay for termination for cause?


 


I am not 100% clear on what I shall do.


 


regards,


 


Jeff

Expert:  Robin D. replied 1 year ago.
Yes you can pay for termination because of cause but you have to be careful how you word the compensation to the employee. You can not just at the time they are terminated give them all reimbursements and they will be taxed on the amount you give them as severance.
I think you are going to need to speak with the DOL on this and ask their assistance in the wording of your severance agreement. (DOL) Department of Labor handles the ERISA issues.
DOL's Toll-Free Help Line at 1-866-4-USA-DOL (1-866-487-2365)
Robin D., Senior Tax Advisor 4
Category: Tax
Satisfied Customers: 7869
Experience: 15years with H & R Block. Divisional leader, Instructor
Robin D. and 7 other Tax Specialists are ready to help you
Customer: replied 1 year ago.

Robin,


 


Excerpt from,<http://www.irs.gov/pub/irs-drop/n-02-45.pdf>, reads:


 


An HRA does not qualify for the exclusion under § 105(b) if any person has the


right to receive cash or any other taxable or non-taxable benefit under the arrangement


other than the reimbursement of medical care expenses. If any person has such a right


under an arrangement currently or for any future year, all distributions to all persons


made from the arrangement in the current tax year are included in gross income, even


amounts paid to reimburse medical care expenses. For example, if an arrangement


pays a death benefit without regard to medical care expenses, no amounts paid under


the arrangement to any person are reimbursements for medical care expenses


excluded under § 105(b). See § 1.105-2 of the Income Tax Regulations. Arrangements


formally outside the HRA that provide for the adjustment of an employee’s


compensation or an employee’s receipt of any other benefit will be considered in4


determining whether the arrangement is an HRA and whether the benefits are eligible


for the exclusions under §§ 106 and 105(b). If, for example, in the year an employee


retires, the employee receives a bonus and the amount of the bonus is related to that


employee’s maximum reimbursement amount remaining in an HRA at the time of


retirement, no amounts paid under the arrangement are reimbursements for medical


care expenses for purposes of § 105(b). Similarly, if an employer provides severance


pay only to employees who have reimbursement amounts remaining in a purported


HRA at the time of termination of employment, no amounts paid under the arrangement


are reimbursements for medical care expenses for purposes of § 105(b).




This sound like what we are trying to set up is not possible without jeopardizing the essence of the program. What do you think?


 


Jeff


 

Expert:  Robin D. replied 1 year ago.
That is why I advised that the wording is so important. I know you probably just wanted to do something very beneficial to the employees but this is just going to be taxable to them if it were under severance payments.
Customer: replied 1 year ago.

Severance being taxable is not a problem. I believe TAX free reimbursements of medical expenses will not be allowed if we set up severance payment based on the balance of the HRA account.

Expert:  Robin D. replied 1 year ago.
That is where the DOL would be beneficial. I can see where you can do that too, but tacking it on the severance is where the problem could happen. You can reimburse for the medical you are right. The balance in the HRA account is the actual stumbling block. I still think that the DOL giving you a difinitive answer would be your saving point on this.
An HRA may provide for the carryover of benefits from year to year, and may specify the types of medical benefits that are covered. An HRA can only be financed by employer contributions, and cannot involve an employee election to participate. So reimbursing any amount from it may fall into the taxable area.
Robin D., Senior Tax Advisor 4
Category: Tax
Satisfied Customers: 7869
Experience: 15years with H & R Block. Divisional leader, Instructor
Robin D. and 7 other Tax Specialists are ready to help you

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Robin D.
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