April 13, 2005
IRS issues Revenue Ruling 2005-24
On April 5, 2005, the IRS issued Revenue Ruling 2005-24 (Ruling) addressing the appropriateness of four different features of medical reimbursement plans (also known as health reimbursement arrangements or HRAs). Specifically addressed are issues regarding the scope of HRAs, types of contributions and the payment of unused reimbursement amounts in cash or other benefits.
Scope of HRAs. The IRS took care to note the ruling applies “to any purported employer-provided medical reimbursement arrangement, regardless of how the arrangement is characterized.” Accordingly, it applies to those plans that provide reimbursement of medical expenses, even though they do not call themselves HRAs or deny that they are HRAs.
Cash payments. The ruling confirms that if a medical reimbursement plan (HRA) provides, directly or indirectly, payment of any benefit other than the reimbursement of medical expenses, amounts paid to an employee under the plan will not be excluded from gross income under Code § 105(b). The IRS identified three specific plan designs that disqualify plans from tax-favored status under Section 105:
- A plan that provides payment of cash equal to all or a portion of a participant’s unused reimbursement amount at the end of the plan year or upon termination, even if such payment is treated as taxable compensation;
- A plan that provides payment of cash equal to all or a portion of the unused reimbursement amount to a designated beneficiary or the participant’s estate upon the participant’s death; and
- A plan that coordinates with an “option plan,” purportedly separate from the reimbursement plan, pursuant to which amounts forfeited under the reimbursement plan are paid in cash or contributed to a retirement plan.
Accordingly, all plans paying, either directly or indirectly through another plan, unused reimbursement amount in cash or other benefits (other than reimbursement of medical expenses) are not entitled to tax-favored status under Section 105.
Contributions of sick leave and vacation. The ruling confirms that in some cases, accrued vacation and sick leave may be contributed by the employer to the HRA without running afoul of nondiscrimination. Under the particular facts addressed in the ruling, upon an employee’s retirement, the employer automatically and on a mandatory basis contributed an amount equal to the value of all or a portion of the retiree’s accrued, unused vacation and sick leave (as determined under the Plan). The employee had no option to receive the value of such accrued vacation or sick leave in cash. According to the rulings, plans with that specific plan design will receive tax-favored status under Section 105. The IRS also generally indicated that the ruling applies to plans covering active employees as well as retirees, or in addition to retirees. Therefore, the ruling appears to sanction mandatory contributions of accrued sick leave and vacation of active employees as well.
Effective date. The ruling indicates that is not “effective” until plan years beginning after December 31, 2005. Because the ruling is consistent with our interpretation of the prior HRA guidance with respect to cash payments, the need for a delayed effective date is unclear. We presume it was included to allow sponsors of plans providing cash payments to amend their plans. Despite the delayed effective date, it is our understanding that once effective, the ruling is effective with respect to all plans and all participants in such plans, even if the plan existed and/or the participant was participating in the plan prior to the effective date of the ruling.