Employee Benefits-IRS Discusses The Tax Treatment Of Contributions Made To An HRA Established For Retirees

In Private Letter Ruling Number 201528004, the IRS faced the following situation, and came to the following conclusions:

The taxpayer currently provides health coverage to eligible retirees, their spouses, their registered domestic partners and their dependents through a choice of health plans. Upon retirement, eligible retirees generally pay premiums for the health coverage with their own after-tax funds. Some retirees are also eligible to have a portion of their accumulated unused sick leave at retirement mandatorily converted to a contribution from the employer to pay for the health insurance premiums. Contributions are uniform and based on hours of sick leave available for conversion and the class of retiree coverage (e.g., retiree-only coverage, retiree-plus-dependent, retiree-plus-family).

The taxpayer proposes to establish a new retiree medical benefit structure in the form of a health reimbursement arrangement for the benefit of eligible retirees, their spouses, their registered domestic partners and their dependents (the “retiree HRA”). Eligible employees hired before a certain date will make an election at retirement to participate in either: (1) existing health plans with premiums funded, in part, by mandatory sick leave conversion, or (2) the retiree HRA funded by mandatory conversion of accumulated unused sick leave at retirement. Retiree HRA contributions are uniform and based on hours of sick leave available for conversion, class of retiree coverage, and Medicare eligibility. The election to waive coverage under the existing health plans may not generally be changed. No other contributions, other than the sick leave conversion, are made to the retiree HRA. The taxpayer represents that amounts in the retiree HRA may be used only to reimburse health insurance premiums and medical expenses as defined in section 213 of the Code. The retiree HRA will not pay claims for registered domestic partner’s medical expenses. Nor will the retiree HRA reimburse spouse’s group health insurance that has been paid with pre-tax dollars. The taxpayer represents that under no circumstance may the eligible retiree or any beneficiary receive any conversion amounts at any time in cash or other benefits. Following the retiree’s death, unused amounts continue for the benefit of the retiree’s spouse, registered domestic partner and eligible dependents (children under 26).

Based on the foregoing, the IRS concludes that:

(1) Taxpayer contributions made to the retiree HRA on behalf of eligible retirees, spouses, and eligible dependents, which are used exclusively to pay for eligible medical expenses, are excludable from the gross income of eligible retirees under section 106 of the Code;

(2) Taxpayer contributions described in (1) are not “wages” and are not subject to FICA taxes under section 3121(a), FUTA taxes under section 3306(b) or income tax withholding under section 3401(a); and
(3) Taxpayer contributions made to the retiree HRA that are used to provide medical coverage for registered domestic partners of eligible retirees (e.g., health insurance premiums) are included in the gross income of eligible retirees under section 61 of the Code.