How to Set Up a Qualified Small Employer HRA (QSEHRA)

A Qualified Small Employer Health Reimbursement Arrangement (QSEHRA) allows small employers to reimburse employees for individual health insurance premiums and other qualified medical costs on a tax-advantaged basis. Established by the 21st Century Cures Act, QSEHRAs provide a new option for small businesses that do not offer traditional group health insurance plans, offering a fixed allowance for healthcare expenses.

Determining Eligibility and Core Rules

Establishing a QSEHRA requires meeting specific employer and employee eligibility criteria. An employer must have fewer than 50 full-time equivalent employees (FTEs) in the preceding calendar year. The employer also cannot provide any group health plan to any of its employees.

All eligible employees must be offered the QSEHRA on the same terms, though certain variations are permissible. These include differences for:
Employees under 25
Part-time or seasonal workers
New hires
Employees covered by a collective bargaining agreement
Non-resident aliens

Employees must maintain minimum essential coverage (MEC) to receive tax-free reimbursements. If an employee does not have MEC, reimbursements may be considered taxable income. Employees enrolled in a group health plan offered by another employer, such as a spouse’s plan, can still utilize QSEHRA funds for out-of-pocket expenses, but reimbursements for premiums from such plans might be taxable depending on the specific circumstances.

Designing Your QSEHRA Plan

Employers must make several decisions when designing a QSEHRA. The Internal Revenue Service (IRS) sets annual maximum reimbursement amounts, which are adjusted for inflation. For 2024, the maximum allowance is $6,150 for self-only employees and $12,450 for employees with families. For 2025, these limits are set to increase to $6,350 for self-only coverage and $12,800 for family coverage.

Eligible medical expenses are generally those defined under Internal Revenue Code Section 213. These typically include health insurance premiums, such as individual plans, marketplace plans, and Medicare parts A, B, C, or D, as well as Medigap premiums. Other qualified medical expenses can also be reimbursed, such as deductibles, co-pays, prescription drugs, and other items listed in IRS Publication 502. The employer’s specific QSEHRA plan document will detail which of these expenses are covered.

Employers determine the specific reimbursement rules for their QSEHRA. This includes deciding whether the plan will cover only premiums or a broader range of medical expenses. The plan can integrate with other forms of health coverage an employee might possess, such as Medicare, allowing for reimbursement of eligible Medicare premiums. Employers also select an effective date for the QSEHRA, which could be influenced by factors such as the start of a new fiscal year or the timing of other benefit offerings.

Preparing the Required Documents

A formal, written plan document is required to establish a QSEHRA, outlining its terms and conditions. This document must include:
Identification of the employer and the designated plan administrator
The benefit year
The maximum annual reimbursement amount
Eligible expenses, often referencing IRS Publication 502
Rules for substantiation of expenses, such as requiring receipts for reimbursement
Rules concerning unused amounts, clarifying whether funds can be carried over to the next year or are forfeited
A statement affirming that the QSEHRA is offered on the same terms to all eligible employees
Procedures for claims and appeals

Employers can obtain or draft this document by using templates, consulting with legal or benefits professionals, or utilizing administration platforms that provide compliant documents.

In addition to the plan document, employers must provide a written notice to all eligible employees. This notice is generally required at least 90 days before the start of the plan year or on an employee’s first day of eligibility if hired mid-year. The notice must:
Inform employees of the maximum amount of the QSEHRA benefit for the year.
Advise employees to inform the Health Insurance Marketplace of their QSEHRA eligibility and the benefit amount, as this may affect their eligibility for premium tax credits.
State that if the employee’s individual health plan does not provide minimum essential coverage (MEC), they may be subject to a penalty, although the individual mandate penalty is currently zero at the federal level.
Clearly explain the tax implications of the QSEHRA: reimbursements are tax-free if the employee maintains MEC, but they become taxable if MEC is not maintained.

Implementing and Managing Your QSEHRA

After preparing the necessary documents, formally adopt the QSEHRA by signing the prepared plan document. Following formal adoption, the written notice must be distributed to all eligible employees in a timely manner, adhering to the 90-day pre-plan year or new hire eligibility requirements.

Managing reimbursements requires establishing an effective administration system. Employers can opt for in-house administration, which involves collecting substantiation documents, verifying employee eligibility, processing payments, and maintaining detailed records. This approach demands careful attention to compliance and record-keeping. Alternatively, many employers choose to use a third-party administrator (TPA), which can streamline the process by handling compliance checks, expense substantiation, and payment processing. TPAs often provide expertise and technology solutions that simplify the ongoing management of the QSEHRA.

The reimbursement process involves employees submitting claims for eligible expenses, often with receipts or explanations of benefits for substantiation. The employer or TPA then reviews these claims against the plan’s rules to ensure eligibility and proper documentation before approving and issuing reimbursements. Proper substantiation is crucial to maintain the tax-advantaged status of the reimbursements. This systematic approach ensures that funds are disbursed correctly and in accordance with the plan design.

Employers have specific tax reporting obligations for QSEHRA reimbursements. The total permitted benefit that an employee is entitled to receive from the QSEHRA for the calendar year must be reported on their Form W-2 in Box 12, using Code “FF.” This amount is reported regardless of how much the employee actually received in reimbursements. For employees who become eligible mid-year or whose benefit level changes, the reported amount must be prorated. Maintaining ongoing compliance involves annually reviewing the plan, updating contribution limits as adjusted by the IRS, and ensuring continued adherence to all eligibility rules and administrative requirements.