The Private Letter Ruling

The PLR was requested by an employer that established an employer-paid reimbursement plan for qualified medical expenses ("the HRA"). The HRA was available only to those employees who had elected, through salary-reduction, to purchase employer-sponsored health insurance. The HRA was not funded, directly or indirectly, by employee salary reductions, and the amount of salary reductions did not exceed the actual cost of the employer-sponsored health insurance.

At the beginning of the plan year, the employer designated a specific annual aggregate amount of reimbursements available from the HRA based on each employee's wages and personal exemptions reported on the Form W-4. Employees with a lower withholding rate received higher reimbursements from the HRA, and those with higher withholdings received a lower amount. The HRA permits carryover of unused balances into the next plan year. In addition, although an annual aggregate amount is designated at the beginning of the plan year, the amount is only available in pro-rata portions that are allocated on each payday.

In the PLR, the IRS concluded the following:

• The HRA in question met the requirements set forth in IRS Revenue Ruling 2002-41 and IRS Notice 2002-45.
• Coverage and reimbursement made under the HRA were excludable from the gross income of participating employees.

Implications of the PLR for Other Sponsors of Health Plans

The PLR, which is applicable only to the taxpayer who requested it, does not add any significant new legal ground to the rules governing HRAs. However, it brings up two interesting design issues:

• An important difference between HRAs and flexible spending arrangements (FSAs) is that an HRA does not have to meet the "uniform coverage" rule. Therefore, reimbursements from the HRA do not have to be available during the entire plan year. In this PLR, the employer only made a pro-rata portion of the HRA money available to employees on each payday and did not allow the entire amount to be available until the end of the year. The IRS did not raise any concerns about this approach.
• The other interesting feature of the HRA in question is that the employer based the amount of reimbursement available from the HRA on the employee's salary and W-4 personal exemptions. While the IRS did not issue an opinion as to whether this plan design violated Internal Revenue Code Section 105(h), the discrimination in this case is in favor of lower paid employees. There is no discussion in the new PLR of details about the plan design or how it is administered. However, the design represents a potentially intriguing method of designing HRAs to assist lower paid employees with health care expenses.