The 21st Century Cures Act introduced a new health reimbursement arrangement (HRA) that allows small employers to continue to reimburse employees for the cost of individual health insurance premiums. Small business employers are able to offer qualified small employer health reimbursement arrangements (QSEHRAs) beginning in 2017 without incurring ACA penalties. QSEHRAs allow a small employer who is not an applicable large employer under the ACA (i.e., one that has fewer than 50 full-time employees) to reimburse employees for the purchase of individual health insurance policies using an HRA if the small employer does not also offer its employees group health coverage.

The employer can contribute a maximum of $6,150 for 2024 ($5,850 for 2023 and $5,450 for 2022) for employees who purchase individual coverage, and a maximum of $12,450 for 2024 ($11,800 in 2023 and $11,050 for 2022)¹ if the employee purchases family coverage (both contribution limits are indexed for inflation and pro-rated amounts are used for years in which only partial coverage is offered).

QSEHRAs must generally be offered on the same basis to all comparable employees, though the employer can exclude employees who have yet to work 90 days, employees who have not reached age 25, employees who are covered by a collective bargaining agreement and employees who are nonresident aliens and have no earned income from U.S. sources. Small business employers who choose to offer QSEHRAs must provide a written notice to employees 90 days before the beginning of the year (the IRS extended the notice deadline for 2017 QSEHRAs²) that specifies the amount of the benefit that will be provided by the QSEHRA and informs participating employees that they must inform the health insurance exchanges of the benefit provided by the QSEHRA if the employee intends to apply for premium assistance.

The notice must also clearly inform the employee that if he or she does not purchase health insurance, ACA penalties may apply and any reimbursements from the QSEHRA may be included in gross income. Small employers must report the QSEHRA coverage on Form W-2, Box 12 (for informational purposes). Further, the employer must provide participating employees with Form 1095-B, and send the same data to the IRS on Form 1094-B.³

Only employers with fewer than 50 full-time employees are eligible to offer qualified small employer health reimbursement arrangements (QSEHRAs).¹

Further, an employer offering a QSEHRA may not otherwise offer a group health plan (including traditional HRAs or health FSAs) to employees, including plans that offer only benefits that are treated as excepted benefits under the ACA (such as dental or vision benefits). For employers that have sponsored non-calendar year plans, eligibility will be lost for any given month if the employer offers health coverage that provides coverage on any day of that month.

The employer is also prohibited from endorsing a particular policy, form or issuer of health insurance, but may provide employees with information about the health insurance marketplaces and premium tax credit without violating this requirement. Employers continue to be eligible to offer QSEHRAs if they only offer coverage to former employees or if the employer continues to allow employees to access funds that were accumulated in a traditional HRA in prior years (or that were carried over from a prior year’s FSA contribution).

S corporations may reimburse two percent shareholder-employees for health insurance premiums without losing their status as “eligible employers.”

Employers that are treated as a single employer under IRC Section 414 are also treated as a single employer for QSEHRA purposes, so that if one employer in the group offers group health coverage, all other employers become ineligible to offer QSEHRAs.

Employers may, however, continue to contribute to employees’ health savings accounts (HSAs) or permit employees to contribute to their own HSAs without losing eligibility for QSEHRA purposes.

If an employer provides a non-calendar year QSEHRA and at some point begins to employ more than 50 employees (so that it becomes an applicable large employer (ALE) that is ineligible to offer a QSEHRA), it becomes ineligible to offer a QSEHRA as of January 1 of the year that it becomes an ALE (i.e., January 1 of the year following the year in which it began to employ 50 or more full-time employees or their equivalent). In this case, the QSEHRA may continue to reimburse employees for expenses incurred during the months of the prior year when the QSEHRA was provided.²

The IRS’ guidance on QSEHRAs outlines when an employee will become eligible to participate in an employer-provided QSEHRA. Generally, the QSEHRA must be provided to all eligible employees, but the employer may exclude the following groups of employees:

• those who have not completed 90 days of service with the employer;
• those who are younger than 25 at the beginning of the plan year;
• part-time or seasonal employees (see below);
• certain nonresident aliens (with no U.S. source income); and
• employees covered by a collective bargaining agreement under which health benefits were the subject of good faith negotiation.

Part-time employees generally include those who work less than 35 hours a week and seasonal employees are those who work less than nine months of the year (if others in similar work with the same employer work substantially more hours or moths). A safe harbor exists for employees who work either less than 25 hours per week or seven months per year.

The QSEHRA may be provided only to current employees, and it may not be provided to non-employee owners. The employer must provide the QSEHRA to an employee on the day immediately following the day following the date an employee is not in a category of excludable employee.¹

---

Planning Point: Employees may not waive their right to participate in the QSEHRA, meaning generally that the employer must provide the QSEHRA, rather than offer the QSEHRA.

---

QSEHRAs must be provided on the same terms to all eligible employees.¹ This means that the program must be administered on a uniform and consistent basis, where the maximum amount of reimbursements may be based only on the age of the covered individuals or the number of individuals covered by the policy.

Despite this, the QSEHRA does not fail the “same terms” requirement if actual reimbursements vary based upon the different expenses submitted for reimbursement. Further, the requirement will not be violated if the QSEHRA will reimburse up to a single set amount regardless of whether the employee has self-only or family coverage, and the arrangement need not refer to the baseline policy. However, if the QSEHRA does vary the permitted benefit based on self-only or family coverage, it must take into account whether the employee’s family members have enrolled in separate coverage (i.e., an employee who selects self-only coverage while his or her spouse enrolls in a different plan must be provided with the QSEHRA benefit that is based on family coverage).

Plans that differentiate in the maximum permissible benefit (based on self-only or family coverage) do not fail to satisfy the same terms requirement merely because they make the determination at the beginning of the plan year and do not provide an option for a change in permitted benefits throughout the year. While the QSEHRA may not reimburse duplicate medical expenses, if two employees are covered under the same plan (i.e., they are married to each other), they must be offered separate benefits regardless of whether they are covered under a single policy or multiple policies.

An arrangement fails to satisfy the same terms requirement if it offers the employee a choice as to which expenses will be reimbursed (i.e., only insurance premium expenses or only non-premium medical expenses). The QSEHRA may limit reimbursements to certain expenses, but will fail the same terms requirement if such a limitation effectively means that the QSEHRA is not available to all employees. QSEHRAs may reimburse for Medicare or Medigap policies, but only if this does not impose a limitation that would make the benefit effectively unavailable for some employees.

Amounts may be carried over from a previous year without violating the same terms requirement (however, the sum of the carried over amount and the permitted benefit in the later year cannot exceed the statutory dollar limit in the later year).

If the employer is a member of a group of employers that is treated as a single employer, the QSEHRA must be provided on the same terms to all employees of all employers in the group.

If the employer provides QSEHRA benefits to a group of excludable employees (i.e., those under age 25, see Q 8810), it must provide the QSEHRA to all members of that class of excludable employees on the same terms as all eligible employees. Because the annual benefit limit is announced relatively late in the year, permitted benefits may be based upon the prior year’s statutory limit without violating the same terms requirement.²

Generally, a QSEHRA may not provide reimbursements in excess of the annual contribution limits ($6,150 for 2024 for self-only coverage and $12,450 for family coverage; $5,850 for self-only coverage and $11,800 for family coverage in 2023).

If the QSEHRA only provides partial year coverage, the dollar limits must be prorated to reflect the months that the individual is covered. QSEHRAs may comply with the statutory dollar limits by using the limits for the immediately preceding year (since the applicable dollar limits are not generally available until October). If the QSEHRA is not a calendar year plan, the dollar limits are prorated based upon the number of months in each portion of the two calendar years. Generally, however, the QSEHRA will not know the dollar amounts three months before the beginning of the non-calendar year plan so as to provide required notice. As a result, the QSEHRA would generally use the dollar limit in place as of the first day of the plan year for the entire plan year. QSEHRAs that allow amounts from the prior year to be carried over into the next year may not add the carried over amounts to the permitted benefit if that would cause the permitted reimbursements to exceed the statutory limit for that year.

The annual statutory limit must also be prorated for newly eligible employees who are only covered by the QSEHRA for a portion of the year. If the employee is a participant on any day of a month, he or she is treated as being eligible for the entire month. If the employee receives reimbursements that equal the statutory limit and later terminates employment (so that he or she is not covered for the entire year), the QSEHRA does not fail to be a QSEHRA because the arrangement is treated as satisfying the dollar limit as of the time the expenses were incurred and reimbursed.

If the QSEHRA is provided for a period that is less than twelve months, the annual statutory dollar amount must be prorated to reflect the number of months in that period.

If an employee participates in more than one QSEHRA and the relevant employers are not treated as members of a single group, each employer may reimburse the employee for up to the annual statutory dollar amount (so long as no single expense is reimbursed more than once).

If a reimbursement is made mistakenly so that the total reimbursements exceed the statutory dollar amount, the employee can repay the reimbursement with after-tax funds to correct the error. The repayment must be made before March 15 of the year following the year in which the excess reimbursement was made or the date the employer receives written notice from the IRS citing the excess reimbursement.¹

Small business employers who choose to provide QSEHRAs must provide a written notice to employees 90 days before the beginning of the year (or 90 days prior to the date the employee becomes eligible to participate in the QSEHRA) that specifies the amount of the benefit that will be provided by the QSEHRA (including information as to pro-ration of benefits that may apply for the year). The notice must also inform employees that they must inform the health insurance exchanges of the benefit provided by the QSEHRA if the employee intends to apply for premium assistance.

The notice must clearly inform the employee that if he or she does not purchase health insurance, ACA penalties may apply and any reimbursements from the QSEHRA will be included in gross income.

The penalty for failure to provide the notice is $50 per employee (with a cap of $2,500 per year). Employers who failed to provide the required notice for 2017 were allowed a cure period provided in IRS Notice 2017-67, so that they were able to provide the notice within 90 days of the date the notice was released (so that the notice was due by February 19, 2018).

Small employers must also report the amount of each employee’s permitted QSEHRA benefit on Form W-2 (this amount will vary for employees who became eligible mid-year and based on family size) without respect to the amount of the benefit that the employee actually uses. If the employer discovers that the employee did not use the funds to purchase health coverage, the employer must report the benefit as wages to the employee in box 1 of the W-2, but not in box 3 (Social Security) or box 5 (Medicare wages). These amounts are also not subject to withholding. Only newly available benefits must be reported—i.e., if the QSEHRA allows for carryover of benefits, the carried over benefits need not be reported.

The employer is not required to provide Form 1095-B to participating employees. Additionally, the employer itself is not required to provide any information to the health insurance marketplace regarding the QSEHRA.¹

In order for reimbursements from a QSEHRA to be received income tax-free by the employee, the reimbursements must related to medical expenses and may not constitute funds that the employee would be entitled to receive regardless of his or her medical expenses. Therefore, all claims for reimbursements must be substantiated (no additional substantiation is required if the sponsoring employer pays the insurance premium costs directly to the insurance company) in the same manner as required of health flexible spending accounts (FSAs).¹ This means that documentation from a third party (such as the insurance company or medical care provider) must be provided.

If reimbursements are mistakenly made when the required substantiation has not been provided, all payments to the employee (whether substantiated or unsubstantiated) on or after the date that the mistaken reimbursement was made are taxable. However, if the employee timely (see below) substantiates or repays the unsubstantiated amounts with after-tax funds, the QSEHRA will be deemed to have satisfied the substantiation requirements. This same treatment applies if the QSEHRA mistakenly reimburses the employee for non-medical expenses.

Substantiation or reimbursement of improperly paid QSEHRA funds is deemed to be untimely if paid after the earlier of (a) March 15 of the year following the year in which the error was identified or (b) if the employer’s tax return is under examination by the IRS, the date the employer receives written notice of the error.²

Pursuant to IRS guidance, amounts reimbursed under a QSEHRA are not treated as being paid for medical expenses under an accident or health plan unless the individual has minimum essential coverage (MEC) for the month to which the amounts relate. If the QSEHRA mistakenly reimburses an employee for medical expenses incurred during a month when he or she did not have MEC, the reimbursed amounts are included in the employee’s gross income.

A QSEHRA is only permitted to reimburse employees for medical expenses after they have received proof that the employee has MEC. This proof should consist of:

• a document from a third party, such as the insurance company, showing that the individual has MEC (an insurance card, for example) and an attestation from the employee that the coverage is MEC; or
• an attestation by the employee that the employee (and any individual for whom the medical expenses were incurred) has MEC, the date the coverage began and the name of the insurance company providing the coverage. The IRS has provided model attestation language in Appendix B to Notice 2017-67.

Initially, this proof must be provided with respect to each individual eligible for QSEHRA reimbursement before the QSEHRA first reimburses any expense of that individual. The employer is entitled to rely upon the employee’s attestations unless it has reason to believe the employee or individual does not have MEC.

In addition to the initial proof, the employee must attest that he or she (and any other relevant individual) has the required MEC (the IRS suggests that this could be made part of the form the employee uses to request reimbursement). The “proof of MEC” requirement applies each year that the QSEHRA is provided (i.e., the “initial proof” must be provided annually).

If the employee fails to provide the required proof, the QSEHRA is not permitted to reimburse the employee with taxable funds.¹

Generally, permissible reimbursements from a qualified small employer health reimbursement arrangement (QSEHRA) are excluded from the employee’s gross income. However, if all QSEHRA funds are not used by year-end, the employer is not permitted to reimburse the employee with a taxable payment of unused benefits at the end of the year (i.e., a “cash out” is not permitted). If the employer cashes out employees, all payments to all eligible employees under the QSEHRA for the year are included in income and wages.

Permissible reimbursements do include reimbursement for an eligible employee’s family member’s health coverage even if the family member’s coverage is separate from the health insurance policy that covers the employee. Further, the QSEHRA may reimburse for group health coverage sponsored by the employee’s spouse, but the reimbursement is taxable to the extent that the spouse’s share of the premiums were paid on a pre-tax basis.

With respect to newly eligible employees, QSEHRA reimbursements may be made as soon as the employee becomes eligible, assuming the employee has satisfied all additional requirements (for example, substantiation) for receiving the reimbursement.

Unlike certain other types of accounts, QSEHRAs are permitted to reimburse employees for over-the-counter drugs purchased without a prescription without jeopardizing qualification, but these reimbursements are taxable because IRC Section 106(f) only permits them to be excluded if a prescription is obtained.

QSEHRAs are permitted to make reimbursements available ratably, on a month-by-month basis, rather than making the full amount of the QSEHRA benefit available at the beginning of the year.

Example: Employer provides a QSEHRA with an annual permitted benefit of $3,000 and provides that $250 of that benefit will be available as each month of the year elapses. Employee submits substantiation for $4,000 in qualified medical expenses in January. The QSEHRA may provide that the employee will receive $250 in reimbursements for the claim each month.

QSEHRAs are not permitted to impose deductible or other cost-sharing requirements before reimbursements become available. QSEHRAs also may not reimburse employees for expenses incurred before the employer provides the employee with the QSEHRA (for this purpose, medical expenses are considered incurred when the care is received, not when the medical bill is paid). However, premium expenses may be treated as though they were incurred (a) on the first day of each month of coverage, on a pro-rata basis, (b) on the first day of the period of coverage or (c) on the date the premium is paid.

While cash outs are not permitted, the QSEHRA may impose a “run out” period following the actual coverage period where the employee is permitted to submit claims for expenses incurred during the coverage period.

Yes. Eligible employers are permitted to allow QSEHRA participants to pay the remainder of a health insurance policy cost (beyond that which is covered by the QSEHRA) via an after-tax payroll deduction.

---

Planning Point: While allowing an after-tax payroll deduction as a means for covering the remainder of any health insurance policy premium cost is technically permitted, employers must be careful to ensure that they are not endorsing any particular health insurance policy or carrier (in order to avoid the conclusion that the employer is sponsoring a group health plan).

---

Self-employed individuals are not allowed a deduction for any month in which a family member is provided a QSEHRA that would pay or reimburse premiums or medical expenses of the self-employed individual.

An employer must generally report the amount of an employee’s permitted benefits under a qualified small employer HRA (QSEHRA) on the employee’s Form W-2 in box 12 (regardless of the payments or reimbursements that the employee actually receives from the QSEHRA).¹ If the amount of the employee’s permitted benefit varies based on the number of family members the QSEHRA covers and the employee provides no proof of minimum essential coverage (MEC), the employer must report the highest permitted benefit that would be possible under the QSEHRA. If the employee later provides proof of MEC that shows he or she was eligible for only a lesser benefit, the employer must report this lesser benefit on Form W-2.

If the QSEHRA has a non-calendar year plan year, the pro-rated amount for the calendar year (rather than the plan year) is reported. If the QSEHRA allows the employee to carry forward amounts from prior years, those amounts are not reported in the subsequent year. If the employee is provided with a QSEHRA for self-only coverage for part of the year, and family coverage for another part of the year, the amount reported must be pro-rated to reflect the change in coverage.

In situations where an employee received a QSEHRA reimbursement that was taxable because it was found that he or she failed to have MEC for the period in question, the taxable amount is included with the employee’s compensation when reporting on Form W-2. Those taxable amounts, however, are excluded from FICA and FUTA taxes, as well as for withholding purposes.² However, if the reimbursement is taxable because the employee used the funds to purchase over-the-counter drugs without a prescription or premiums that were paid on a pre-tax basis for group health plan coverage sponsored by the employee’s spouse’s employer, those amounts are included for FICA, FUTA and withholding purposes. In any event, the permitted benefit reported in box 12 will be the same as it would have been without the failure to maintain MEC and regardless of how the employee used the funds.

A corrected Form W-2c is required if the employer discovers the failure to maintain MEC after the original W-2 was filed.

The employer is not required to complete Form 1095-B.³

Generally, an employee is eligible for a premium tax credit if he or she (1) is enrolled in a qualified plan through the health insurance marketplace and (2) is not eligible for employer-provided coverage that constitutes minimum essential coverage that is affordable and provides minimum value. The coverage is considered affordable if the employee contribution is less than 9.5 percent (as adjusted for inflation, 9.12 percent in 2023, 9.61 percent in 2022 and 9.83 percent in 2021) of his or her household income. Once this is satisfied, the taxpayer is only eligible for the premium tax credit during “coverage months.”¹

“Coverage month” means a month where (1) the taxpayer or family member is enrolled in a qualified marketplace plan and is not eligible for another qualified plan and (2) the premium is paid by the original due date for the taxpayer’s tax return. Employees (and their family members) do not have a coverage month if they are provided with a QSEHRA that is affordable coverage.² A QSEHRA is affordable coverage for the month if the excess of the monthly premium for the self-only second lowest cost silver plan over 1/12 of the employee’s permitted benefit does not exceed 1/12 of 9.5 percent of the employee’s household income.³

Although tax reform suspended the availability of the personal exemption for 2018-2025, prior IRS guidance provided that if an employee is provided an affordable QSEHRA for any coverage month, the premium tax credit allocated to the person claiming the personal exemption with respect to that employee must be reduced by 1/12 of the employee’s permitted benefit for that month.⁴ Logically, this rule will require modification unless the personal exemption is reinstated after the suspension is set to expire after 2025.

The maximum permitted benefit for self-only coverage is used to determine whether the QSEHRA is affordable, regardless of whether family coverage is available to certain employees. However, if the premium tax credit amount must be reduced, the maximum permitted benefit for the actual coverage type in which the employee is enrolled is used. If the employee has family coverage for a portion of the year and self-only coverage for other months, the pro-rated benefit levels are used.

If the QSEHRA is only provided for some months of the year, affordability is determined for each month using the pro-rated benefit for self-only coverage. Similarly, pro-rated benefit levels are used to determine any reduction in the available premium tax credit.

Carryover amounts from a prior tax year do not impact the affordability determination in the subsequent year (however, the sum of the permitted benefit and carryover amount cannot exceed the statutory limit in the subsequent year, see Q 8800).

If the marketplace determines that the QSEHRA is not affordable when the employee enrolls in the marketplace plan, the QSEHRA is treated as unaffordable for all months of the year, regardless of whether it later would actually satisfy the affordability test.⁵

Generally, an individual with a high deductible health plan (HDHP) and no other disqualifying health coverage is eligible to contribute to a health savings account (HSA).¹ If an employee is provided a qualifying small employer HRA (QSEHRA) that reimburses any medical expense, including any cost sharing required by the employee’s health insurance, he or she is disqualified from also contributing to an HSA.

However, if the QSEHRA may only reimburse premium costs, the employee may also contribute to an HSA. Further, the QSEHRA may reimburse for expenses that qualify as permitted insurance or disregarded coverage under IRC Section 223(c) without jeopardizing HSA eligibility.

When an employer terminates a group health plan that it had provided in favor of providing employees QSEHRAs, the employee can take into account any unreimbursed medical expenses incurred by the employee when covered by the group health plan if he or she later decides to purchase a HDHP (i.e., for purposes of the HDHP deductible).²

If a qualified small employer HRA (QSEHRA) fails to satisfy the requirements discussed in Q 8809 to Q 8823, the arrangement will be treated as a group health plan that is subject to Chapter 100. As such, any violation becomes subject to a $100 penalty per affected person per day.¹

For example, a QSEHRA can fail to satisfy the requirements if it is not provided by an eligible employer, if it is not provided to all eligible employees on the same terms, if it reimburses medical expenses without first requiring proof that the individual has minimum essential coverage or if it provides benefits that exceed the annual contribution limit. Failure to provide the required notices does not cause the QSEHRA to fail to be a QSEHRA, but instead triggers application of the penalty discussed in Q 8813.

Failing to satisfy the QSEHRA requirements does not cause reimbursements for properly substantiated medical expenses to be included in the employee’s income, but if the arrangement is actually designed to reimburse non-medical expenses (even if in addition to medical expense reimbursement), all reimbursements will be included in the employee’s income.

Essentially, all QSEHRA reimbursements will be included in employee income if any of the following are true: (1) the QSEHRA reimburses medical expenses without proper substantiation, (2) the QSEHRA reimburses medical expenses in advance of receiving substantiation or (3) the QSEHRA reimburses non-medical expenses.