Health reimbursement arrangements (HRAs) for sole proprietors

Health insurance coverage is a great perk that all types of business owners should strive to provide to their teams. But sole proprietors who want to participate in their own health benefit may be unable to take advantage of every health plan.

One such health benefit that a sole propriety may have questions about is a health reimbursement arrangement (HRA). An HRA is a tax-advantaged, employer-funded benefit for eligible employees to receive reimbursements for their qualified medical expenses.

HRAs are attractive to employers because they’re flexible and diverse enough to meet every employee’s needs. They’re also an affordable option for employers on a budget—like many sole proprietors that are in their first years of business. But how can self-employed individuals benefit from an HRA while complying with IRS regulations?

This article will explain how sole proprietors can offer an HRA as well as whether or not they can participate in an HRA. We’ll also describe how health stipends can work for sole proprietorships as an alternative to HRAs.

What is a sole proprietor?

A sole proprietor is a self-employed individual who owns and operates an unincorporated business. An unincorporated business refers to any business not created or treated as a corporation or limited liability company (LLC).

Sole proprietorships are a popular company structure for entrepreneurs to establish and operate because they aren’t subject to as many government regulations as other businesses.

For instance, sole proprietors without employees who don’t file excise or pension tax returns don’t have to file for an employer identification number (EIN). In this case, individuals can create the business using their social security number (SSN).

While many sole proprietorships choose to stay classified as a non-registered businesses, they can grow into LLCs or corporations. Once this occurs, the company is subject to greater federal government regulations.

How sole proprietors can take advantage of HRAs

The IRS doesn’t consider sole proprietors employees of their own companies. Because of this, they can’t directly participate in an HRA, as only W-2 employees are eligible for the benefit. But if a sole proprietor employs their legal spouse as a W-2 employee at their business, they can indirectly take advantage of the HRA and receive health savings.

The spouse can cover the sole proprietor—and any eligible children—as dependents on the HRA, and enable them to use their tax-advantaged allowance to purchase a health policy and medical services. If the spouse has a health insurance plan that meets minimum essential coverage (MEC), all HRA reimbursements are income tax-free for them, the sole proprietor, and other covered dependents.

As a sole proprietor, you can choose how much of an allowance you want to offer on a monthly basis to your W-2 employees. This helps you save money compared to small group health insurance and makes your benefits costs more predictable.

HRA reimbursements are also tax deductible for business owners and free of payroll taxes.

The following are three of the most popular types of HRAs:

• Qualified small employer HRA (QSEHRA): This is a flexible health benefit specifically designed for small employers with fewer than 50 full-time equivalent employees (FTEs).
• Individual coverage HRA (ICHRA): This is a stand-alone HRA for employers of all sizes that want to customize allowances and eligibility by employee classes.
• Group coverage HRA (GCHRA): Also known as an integrated HRA, a GCHRA allows organizations to supplement their existing group health insurance policy by covering out-of-pocket expenses the group plan doesn’t.

Per federal regulations, you must offer the QSEHRA to all your W-2 employees—not just your spouse. But you can customize eligibility by employee classes with an ICHRA or GCHRA. When designing an HRA, you must provide legal plan documents outlining eligibility, allowance amounts, effective dates, and more to all eligible employees receiving the benefit.

To ensure you meet all the necessary IRS requirements, you can use a third-party administrator (TPA) or HRA benefits administration software, like PeopleKeep, to help you design a compliant HRA.

Health stipends as an alternative to HRAs

HRAs are an excellent way for sole proprietors to offer their employees health benefits. But if you’re looking for a benefit with fewer regulations that can still cover your employees’ medical expenses, you may want to consider a health stipend.

Stipends are essentially extra wages added to an employee’s paycheck, which they can spend on whatever they choose. Health stipends are customizable, have no contribution limits, and are available to all types of employees, like 1099 contractors or gig workers.

While they’re not health insurance policies, they can be used to cover out-of-pocket costs that most HRAs and traditional employer-sponsored plans may not allow, like fitness classes.

You can’t require your employees to use their stipend money on medical care or request proof that they used their stipend on a health insurance plan or other medical expenses. The IRS also considers stipends taxable income for employees, and employers are subject to payroll taxes on reimbursements.

Self-employed business owners aren’t legally able to receive a salary or wages like regular employees. They pay themselves by withdrawing funds from their business income, either by check or by transferring funds between their business and personal bank accounts.

They also don’t receive a Form W-2 and pay different taxes from their employees, like the self-employment tax¹. As always, if you need help understanding your tax liability as a self-employed individual, contact a tax professional or financial advisor.

Because health stipends are extra wages included on an employee’s W-2, where the government withholds Social Security, Medicare, and income taxes, sole proprietors aren’t eligible to receive stipends.

But like HRAs, the sole proprietor’s spouse can participate in the stipend, and together they can use the extra income to pay for health insurance premiums and other out-of-pocket medical costs.

Since they’re less regulated, you can offer a stipend to any employee you like, whether it’s just your spouse or all your employees. But offering a stipend is a great way to increase retention and morale, so allowing more employees to participate in the benefit is a great way to stay competitive and combat the rising cost of health insurance.

Conclusion

Whether you run a sole proprietorship or a corporation, offering a wide range of customizable perks is a great way to keep your employees happy and at your company for the long haul. Even though sole proprietors can’t directly participate in an HRA or health stipend, if your spouse is an employee, you can still reap the benefits of implementing one at your organization.

Self-employed individuals are busy running their companies. So let us help you run your benefits! At PeopleKeep, you can design and manage personalized HRAs in minutes each month with our benefits administration software. Contact us today to learn how to get started.

This article was originally published on January 23, 2013. It was last updated on August 21, 2023.

1. https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center#:~:text=Back%20to%20top-,What%20are%20My%20Self%2DEmployed%20Tax%20Obligations%3F,-As%20a%20self