Businesses and their employees are always looking for better ways to handle increasing healthcare costs and get the most out of tax benefits. Health Reimbursement Arrangements (HRAs) have become a really useful solution for this, offering significant financial advantages thanks to how they’re taxed. If you are a business owner (or an employee doing research to advocate for better benefits), it is important to take the time to learn more about how HRAs work from a tax standpoint and why they’ve become such a popular part of a complete benefits package.
What Exactly Is an HRA?
A Health Reimbursement Arrangement is an employer-funded health benefit that allows businesses to reimburse employees for qualified medical expenses and, in some cases, health insurance premiums. Unlike Health Savings Accounts (HSAs) or Flexible Spending Accounts (FSAs), HRAs are exclusively employer-funded, with no employee contributions permitted.
The fundamental structure is straightforward: employers determine a set amount of money to make available to employees, employees incur qualified medical expenses, submit documentation for those expenses, and receive tax-free reimbursement up to their available balance. This seemingly simple arrangement creates substantial tax advantages for both parties.
Tax Benefits for Employers
100% Tax Deductibility
Perhaps the most significant advantage for businesses implementing HRAs is that all reimbursements are fully tax-deductible as business expenses. Unlike direct salary increases, which trigger payroll taxes of approximately 7.65% (for Social Security and Medicare), HRA reimbursements avoid these additional tax burdens entirely.
For example, if a company provides $50,000 in HRA reimbursements across all employees during a tax year, that entire amount can be deducted from the business’s taxable income. For businesses in higher tax brackets, this deduction represents substantial savings that improve overall cash flow and financial performance.
Payroll Tax Savings
When employers increase employee compensation through HRAs rather than equivalent salary increases, they avoid the employer portion of FICA taxes (7.65%). This creates an immediate tax saving of $7,650 for every $100,000 distributed through the HRA program instead of through regular payroll.
For growing businesses especially, these savings compound over time and can significantly impact the company’s financial health. This makes HRAs particularly attractive for businesses looking to provide valuable benefits while managing their tax liability strategically.
Flexibility in Design and Implementation
Unlike many heavily regulated benefit programs, HRAs offer employers considerable flexibility in their design. Businesses can:
- Set different allowance amounts based on employee classifications
- Determine which qualified medical expenses will be eligible for reimbursement
- Establish rollover policies for unused funds
- Integrate HRAs with existing health insurance offerings
This flexibility allows businesses to create customized benefits packages that address their specific workforce needs while still capitalizing on the available tax advantages.
Tax Benefits for Employees
Tax-Free Reimbursements
For employees, the principal benefit is receiving completely tax-free reimbursements for qualified healthcare expenses. Unlike regular compensation, HRA reimbursements are excluded from:
- Federal income tax
- State income tax (in most states)
- Social Security and Medicare taxes
This tax treatment effectively increases the value of each dollar received through an HRA compared to the same dollar received as salary. An employee in the 24% federal tax bracket who receives a $5,000 HRA reimbursement effectively receives the equivalent of over $6,500 in pre-tax salary when factoring in all applicable taxes.
Expanded Access to Healthcare Options
With tax-free funds available specifically for healthcare expenses, employees often find themselves able to pursue medical care they might otherwise delay or avoid due to cost concerns. This can lead to earlier intervention for health issues, potentially reducing long-term healthcare costs and improving overall employee wellness and productivity.
No “Use It or Lose It” Requirement
Unlike Flexible Spending Accounts (FSAs), HRAs don’t necessarily include the notorious “use it or lose it” provision that requires funds to be spent within a plan year. While policies vary by employer, many HRAs allow for some form of rollover of unused funds, providing greater flexibility for employees with varying healthcare needs.
Common HRA Variants and Their Tax Implications
Qualified Small Employer HRA (QSEHRA)
Designed specifically for businesses with fewer than 50 full-time equivalent employees that don’t offer group health insurance, QSEHRAs allow employers to provide tax-free reimbursements for individual health insurance premiums and qualified medical expenses.
For 2025, contribution limits are set at $6,150 for individual coverage and $12,450 for family coverage. These reimbursements remain tax-free for employees as long as they maintain minimum essential coverage as defined by the Affordable Care Act.
Individual Coverage HRA (ICHRA)
The ICHRA, introduced in 2020, allows businesses of any size to reimburse employees tax-free for individual health insurance premiums and other qualified medical expenses. Unlike QSEHRAs, ICHRAs have no annual contribution limits, giving employers significant flexibility in designing their benefits.
ICHRAs also allow for different reimbursement amounts based on legitimate job-based classifications, creating opportunities for more targeted benefits packages while maintaining tax advantages.
Excepted Benefit HRA (EBHRA)
With contribution limits of $2,100 per employee in 2025, EBHRAs can be offered alongside traditional group health coverage to reimburse certain qualified medical expenses that the primary insurance doesn’t cover. While more limited in scope, these still provide tax advantages for both employers and employees for expenses like dental and vision care.
Compliance Considerations for Tax-Free Status
For HRAs to maintain their favorable tax treatment, employers must ensure strict compliance with IRS regulations and Department of Labor requirements. Key compliance considerations include:
- Written Plan Documentation: The HRA must be formalized in writing with clear terms and conditions
- Substantiation Requirements: All reimbursed expenses must be properly documented with receipts or explanations of benefits
- Annual Reporting: Depending on company size and HRA type, various reporting requirements may apply
- Non-Discrimination Testing: HRAs cannot unduly favor highly compensated employees
Failure to meet these requirements can result in disqualified expenses being treated as taxable income for employees and potential penalties for employers.
Strategic Implementation for Maximum Tax Benefits
To maximize the tax advantages of HRAs, businesses should:
- Integrate HRA planning with overall tax strategy
- Consider employee demographics when determining allowance amounts
- Evaluate HRAs alongside other tax-advantaged benefits like HSAs
- Provide clear education to employees about the tax advantages of HRAs compared to regular compensation
- Maintain meticulous documentation and compliance protocols
When properly implemented, HRAs create a financial win-win: businesses reduce their tax liability while providing employees with highly valued benefits that stretch their healthcare dollars further.
As healthcare benefits continue to evolve, HRAs are likely to remain a cornerstone of tax-efficient benefits strategies, particularly as businesses seek creative ways to attract and retain talent while managing their bottom line. For businesses looking to optimize their benefits offerings while minimizing tax liability, understanding and implementing the right HRA model represents a strategic opportunity with both immediate and long-term financial advantages.
By providing this valuable tax-free benefit, employers demonstrate their commitment to employee wellbeing while simultaneously strengthening their own financial position—truly a remarkable achievement in today’s challenging business environment.
Read more: Settlements vs. Court: How Public Liability Cases Are Usually Resolved
