Taxability and Reporting Related To Cafeteria (125) plans, HRAs, and HSAs

1. Taxability and Reporting Related ToCafeteria (125) plans, HRAs, and HSAs Presented by Robert A. Buss, Jr., CPA, CEBS– Wipfli LLP 920-662-2851 bbuss@wipfli.com Sr. Manager – Employee Benefits

2. Health Flexible Spending Accounts (Health FSAs)

3. Cafeteria (125) plans – What Are They? PARTS • Premium feature (dental, health, vision, group term life, disability) • Health Flexible Spending Arrangement (HFSA) • Dependent Care Assistance Program (DCAP) • Health Savings Accounts (HSAs) • Allows employees to pay for medical expenses using pretax dollars – IRC 213(d) • IRS treats Health FSA as a self-funded health plan

4. Health FSA • Generally funded by employee pre-tax payroll deductions (although employer contributions are allowed) • Employee participation only but can submit claims for expenses incurred by spouses and dependents • Sole proprietors, partners, & 2%+ shareholders in S-corp/LLC can’t participate • Ineligibility applies to spouses and children employees of S-corp shareholders, but not to sole proprietor/partnership/LLC spouses and children

5. Health FSA • Reimbursement of most medical expenses (administrator must review claims to ensure they are valid) • Insurance co-pays (not premiums) • Deductibles • Glasses • Orthodontia • Prescription drugs

6. Health FSA • Coverage limited to plan year • Expenses must be incurred during plan year • Annual election – midyear election changes prohibited except for certain qualifying events • Uniform coverage – employee has access to entire amount of annual election at any time during year. • Example: employee electing $1,200, can receive reimbursement for whole amount in January, even though only $100 withheld from check.

7. Health FSA • Reimbursement of Claims • Expenses must be incurred during plan year • Typically allow for 30-60 day run out period after plan year end • Cash outs generally prohibited • Can provide for grace period of up to 2½ months after year end during which claims may be incurred • FSA limit is set by employer, but cannot exceed $2,500 effective January 1, 2013

8. Health FSA • Important - If contributing to an HSA (through spouse's employer or group plan), the cafeteria plan document should be amended to provide for a "limited purpose" FSA.  A limited purpose FSA can only reimburse for dental, vision, and preventative care expenses as well as medical expenses incurred that are in excess of the deductible limits.

9. Health Reimbursement Arrangements (HRAs)

10. HRAs — What Are They? • Health Reimbursement Arrangement • Self-funded health and welfare plan under § 105 of the tax code • Employer creates an “account” for each participating employee that is then used by the employee to pay for medical expenses

11. HRA Requirements • There are TWO MUST requirements of HRA plan design: • MUST be employer dollars. Cannot be funded by employee dollars either directly or indirectly. • ONLY Medical Expenses can be reimbursed

12. HRA - Who Can Participate? • Employees (subject to nondiscrimination rules) • Spouses and dependents • Sole proprietors, partners, & 2%+ shareholders in S-corp/LLC cannot participate • Spouses and children of above owners who are bona fide employees can participate

13. Great Flexibility in an HRA • All other design issues are truly optional: • May be connected to a High Deductible plan • May allow different benefit dollars for different tiering (single, single +1, family) • Employer allocations can be made all at once or on a periodic basis, i.e uniform coverage need not apply • Expense need not be incurred during plan year • May allow rollover of unused funds • May have a maximum benefit “bank” • Employer can determine order of payout – employee pays first, HRA pays first, employee/HRA share responsibility • May allow insurance premiums (HIPAA/COBRA concerns)

14. What HRA Plan Design Options are Excluded? • No Cash Out • Death Benefits – spouse and dependents can use the benefit for eligible expenses • Long-Term Care expenses (however, LTC premiums can be reimbursed) • No reimbursement of expenses reimbursed under another plan or deducted by the participant (no double dipping) • No reimbursement of employee’s share of the premiums for employer’s major medical coverage

15. Affordable Care Act (ACA) Impact W-2 Reporting of Health Insurance Benefits • Memo box only for cost of insurance coverage, Box 12, Code DD. • May use actual or COBRA applicable premium. • For 2013 reporting, only if over 250 W-2s. • Expected to be expanded to all employers in 2014 or 2015. Withholding/Reporting of Medicare Tax Effective January 1, 2013 • Employee only share of .9% withheld on wages exceeding $200,000.

16. Health Savings Accounts (HSAs)

17. HSAs – What Are They? • Individual savings accounts owned by the employee used to pay medical expenses– similar to IRAs. • Eligible contributions are deductible and distributions/earnings are tax-free • Mustbe associated with a High Deductible Health Plan (HDHP)

18. HSAs – Who Can Participate? • Employees covered by a qualified HDHP and not covered by a non-HDHP • Expenses for spouses and dependents can be reimbursed • Sole proprietors, partners and 2%+ shareholders in a S-Corp/LLC can participate; cannot make pre-tax contributions, although tax deduction can still be taken • Ineligibility applies to spouse and children employees of S-corp shareholders as well

19. What is a Qualified HDHP? • Annual deductible of at least $1,250 for self coverage and $2,500 for family for 2013/2014 (indexed for inflation) • No co-pay or co-insurance until the deductible is met, except for preventive • Maximum out-of-pocket expenses cannot exceed $6,250/$6,350 for self and $12,500/$12,700 for family coverage for 2013/2014, respectively (indexed for inflation)

20. Non-HDHP Coverage • HSA account holder may not have coverage under any other plan that is not an HDHP. • Spouse’s employer’s health plan or Health FSA • General purpose Health FSA* • Spouse and dependents can have nonHDHP coverage as long as HSA account holder is not covered by those plans. • Employer can offer both HDHP and nonHDHP plans as long as HSA participants do not take nonHDHP coverage. *Can be designed to be compatible with HSA.

21. What Non-HDHPs Are Allowed? • Dental Plans • Vision Plans • Disability (STD and LTD) • Long-term care • Health FSAs/HRA that covers only dental/vision and unreimbursed medical expenses after HDHP deductible is met

22. Contributions to an HSA • Both employees and employers can contribute • Employer contributions are optional

23. Contribution Limits • Maximum annual contribution/deduction: • $3,250/$3,300 for self and $6,450/$6,550 for family coverage for 2013/2014, respectively (indexed for inflation) • Employee age 55+ and not enrolled in Medicare may make additional “catch up” contribution of $1,000 • Spouse can make additional catch-up contribution if spouse has their own HSA.

24. Contribution Limits • If an individual enters the plan mid-year (does not have 12 months of HDHP coverage), the individual may still contribute the maximum amounts, provided that the individual maintains HDHP coverage for the entire year following the year in which HDHP coverage began and HDHP coverage begins on or before December 1. • Both employee and employer contributions count towards maximum

25. Contributions Are Non-forfeitable • All contributions are immediately owned by employee and can’t be forfeited • Unused balance rolls over from year-to-year • Accounts are portable at termination of employment • Employee can continue to contribute to HSA if employee has HDHP (e.g., COBRA, new employer, individual policy) • If no HDHP, no new contributions are allowed but can still withdraw funds for medical expenses tax free and funds grow tax free

26. Contributions and Cafeteria Plans • Employee contributions: • Employee contributions can be made pretax through a cafeteria plan (except for 2% shareholders in S-corp/LLC) • Cafeteria plan midyear election change rules do not apply to HSA contributions (contributions can be changed monthly) • Employee contributions not made through a cafeteria plan are deductible on employee’s tax return at the end of the year, but are subject to FICA/Medicare tax

27. Contributions and Cafeteria Plans • Employer contributions: • Employer contributions can be made either inside or outside of a cafeteria plan • Employer contributions are not subject to federal taxes (except as previously noted for certain owners) • Employer contributions (including employee contributions through a cafeteria plan) must be reported on W-2 at the end of the year

28. Contributions and Cafeteria Plans • Employer contributions outsidea cafeteria plan are subject to a comparability rule • All employees enrolled in any HDHP offered by employer must receive equal HSA contribution, with two exceptions: • Full-time v. Part-time • Self v. Family Coverage • No matching contributions outside cafeteria plan

29. Contributions and Cafeteria Plans • Employer contributions inside a cafeteria plan are not subject to comparability rule • But must pass cafeteria plan nondiscrimination testing prohibiting excess benefits to highly compensated employees • Matching contributions may be allowed

30. HSA Distributions • HSA funds can be used to pay for qualified medical expenses of employee, spouse, & dependents • Employee (not employer) is responsible for determining qualified medical expenses (employee education crucial) • Distributions for nonqualified expenses are subject to income tax • Distributions for nonqualified expenses are also subject to 20% penalty until age 65

31. HSA Qualified Medical Expenses • All expenses incurred for medical care • HSA funds cannot be used to pay for health insurance premiums except for the following: • COBRA coverage • Long-term care insurance • Health insurance maintained while receiving unemployment • Health insurance for participants over 65 (except for Medicare supplements) including Medicare A or B" which can be reimbursed.  Medigap policies are not eligible

32. HSAs & Federal Taxes • Employee contributions – 1) Pretax deductions through cafeteria plan, or 2)deductible on federal income tax return • Employer contributions Most employees – Included on W-2 for reporting purposes only (along with employee contributions through a cafeteria plan) S-Corp shareholders – Included on W-2 as taxable income and for reporting purposes

33. HSAs & State Taxes • State tax consequences will generally depend on state where employee resides • Only a few states tax HSAs – California & New Jersey • Wisconsin adopted federal provisions effective January 1, 2011 • See chart for HSA and cafeteria plan payroll tax reporting

34. Thank You!