IRS Forbids Certain Beneficiary Designations

The IRS recently confirmed what many knew already about taxability of certain payments from Health Reimbursement Arrangements (HRAs).

Revenue Ruling 2006-36, issued in August, addressed whether HRAs and other similar reimbursement plans may pay benefits to a designated beneficiary who is not the employee, the employee’s spouse or the employee’s dependents. The short answer is no, they may not. If they do, those amounts are includable in the employee’s gross income.

In the event of an employee’s death, the surviving spouse and dependent(s) may use the remaining balance if the plan has an appropriate spend-down option or if they elect and pay for COBRA. However, if no spouse or dependent exists, an HRA may not give the remaining balance to someone else, even if the deceased employee designated a beneficiary and even if the beneficiary uses the amount only for legitimate medical expenses.

What if your plan has such a provision? Fortunately, the IRS provided some relief by delaying the effective date of its ruling. If an HRA or other plan already had such a designated beneficiary provision before August 14, 2006, the Ruling becomes effective for plan years starting on or after January 1, 2009. HRAs and other plans are now prohibited from adding such an option as of August 14, 2006.

Clients who use Infinisource for HRA administration should know that the plan documents we supply were properly worded. Therefore, changes will not be required. These plan documents do allow for payments to a person’s estate in a related circumstance: when reimbursement of previously incurred medical expenses of the employee does not occur until after the employee’s death. Such a provision is permissible.

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