CHOICE (ICHRA) Rules for Business Owners: Which Owners Can Participate?

The CHOICE (Custom Health Option and Individual Care Expense Arrangement), previously known as ICHRA (Individual Coverage Health Reimbursement Arrangement) is a modern way for employers to offer health benefits. 

As more groups implement this alternative to group health policies, some business owners wonder if they can participate in their company’s CHOICE alongside their employees. The answer depends on IRS rules related to your business structure and owner status.

In this article, we’ll cover the following: 

• How a CHOICE differs from traditional group health insurance
• Which types of business owners can (and cannot) participate in a CHOICE
• What options owners have if they aren’t eligible for a CHOICE

CHOICE vs. traditional group health: key differences 

A CHOICE is not a health insurance policy itself. Instead, it’s an employer-funded arrangement that covers the cost of employees’ own individual insurance premiums and (optionally) other medical expenses. Listed below are some key differences between this benefit and a group health insurance policy: 

• Coverage and choice: With a group plan, all employees (and eligible owners) generally enroll in the same insurance policy chosen by the employer. With a CHOICE, employees pick the individual health plan that suits them and uses an employer-provided allowance to cover the cost of that plan. This gives employees more choice and flexibility in coverage.
• Cost control: Employers set a fixed budget for a CHOICE, which can make costs more predictable. By contrast, group insurance premiums can fluctuate annually and often require the employer to pay a certain percentage of the premium. 
• Participation rules: Traditional group plans typically require a minimum number of participants or a minimum employer contribution. CHOICE arrangements have no such requirements.  

Even though a CHOICE is not a health insurance policy, it is still considered a formal employee benefit plan and is impacted by federal laws like the Employee Retirement Income Security Act (ERISA) and the Affordable Care Act (ACA). The laws that govern CHOICE arrangements also impact which types of business owners can participate in the benefit. 

Which types of business owners can participate in a CHOICE?

CHOICE eligibility for owners depends on whether the owner can be classified as an employee of the business. The IRS stipulates that HRA benefits (including CHOICE arrangements) can be provided tax-free only to current or former employees and their families¹. Owners who are considered “self-employed” or otherwise not considered employees may not participate in a CHOICE. Here’s how that impacts each type of business owner: 

• C-corporation owners: Since a C-corporation is a separate legal entity than its owners, C-corp owners who pay themselves a salary through this type of business are considered W-2 employees. Therefore, they can participate in their company’s CHOICE.
• S-corporation owners: The IRS states that an S-corp shareholder who owns more than 2% of their company is not considered an employee and therefore cannot participate in a qualified small employer health reimbursement arrangement (QSEHRA). The same rule applies to CHOICE. Employees who own 2% or less of an S-corp can participate. 
• Partnership owners (partners in a partnership or LLC taxed as partnership): Partners in a partnership are not considered employees by the IRS. Because they are self-employed for tax purposes, they cannot participate in a CHOICE². However, if the spouse of a partner is a W-2 employee and is not themselves a partner or owner, the partner may be eligible to participate in a CHOICE as a covered dependent. 
• Sole proprietors: A sole proprietor is the same legal entity as their business and is not considered a W-2 employee. Therefore, they are not eligible to participate in a CHOICE. However, similar to partnership owners, if a spouse of a sole proprietor is a W-2 employee, they can participate in the benefit as a covered dependent. 
• LLC owners: Whether or not an owner of an LLC can participate in a CHOICE is dependent on how the LLC is taxed. By default, the IRS treats a single-member LLC as a sole proprietorship and a multi-member LLC as a partnership. Owners can elect to classify their LLC as a C-corp or an S-corp by filing Forms 8832 or 2553. In any case, the rules that apply to the owners of the business types listed above would apply to LLC owners as well. 

Why do these restrictions exist?

Why are owners of S-corps, partnerships, and sole proprietorships barred from CHOICE participation? The reasoning comes from the tax code: only employees can receive fringe benefits like health reimbursements tax-free. 

This prevents these owners from getting a special tax reimbursement from a business they already own. Instead, they are expected to handle obtaining health insurance coverage in another way (such as through self-employment health insurance deductions, which will be covered next).

By contrast, a C-corp owner is not considered self-employed because the corporation is a separate entity and the owner is an employee of their own company. That’s why C-corporation owners can fully participate in CHOICE arrangements or other benefits as long as they’re on payroll. 

It’s worth noting that the same rules don’t apply to traditional group health insurance plans. When it comes to group health policies, any employee (including owner-employees) can enroll. However, tax treatment of their premiums is altered depending on the type of owner they are. 

Because a CHOICE is a tax-free reimbursement vehicle, the IRS draws a line on owner eligibility upfront rather than simply altering the tax treatment.

Options for business owners ineligible for CHOICE

If you’re an owner who falls into an ineligible category, you cannot receive a tax-free allowance through a CHOICE for your own health insurance. However, this doesn’t mean you’re without any recourse. Here are some alternatives you can leverage:

• Use the self-employed health insurance deduction: Owners who are considered self-employed (including partners, sole proprietors, and S-corp owners with a greater than 2% stake) can deduct up to 100% the cost of health insurance premiums they pay for themselves, their spouse, and their dependents on their personal income tax return, according to Internal Revenue Code § 162. This is an “above-the-line” deduction that directly reduces your adjusted gross income. To qualify, your business must have had a profit, and you (or your spouse) must not have access to a subsidized group health plan elsewhere. 
• Offer the CHOICE to a spouse who’s an eligible employee and participate as a dependent: If your spouse works in your business and is not an owner, you have a creative workaround. You can offer the CHOICE to your spouse as a legitimate W-2 employee. The spouse can then purchase a family health insurance plan on the individual market that covers both of you (and any children), and use the CHOICE funds toward that plan’s premiums. In this scenario, the spouse is the CHOICE participant, and you (the owner) are simply a family member on their plan. 
• Leverage Vitable Primary Care as a benefit: If you sign your business up for Vitable Health’s care-backed CHOICE and can’t participate in the CHOICE yourself, you can still access Vitable Health’s primary care solution. This high-touch benefit offers unlimited virtual primary care, plus access to more than 1,000 free prescriptions, routine labs and diagnostic testing, mental health coaching, and more. With this solution, you can create a pathway to access everyday care, even without access to the CHOICE. 

Finally, remember that being ineligible for the CHOICE doesn’t stop you from offering it to your employees. Many owners set up a CHOICE to better care for their employees and cover their own insurance needs separately. 

Owners who sign their business up for a CHOICE are able to provide a valuable benefit with predictable costs, while handling their own insurance needs through one of the methods listed above. So, even if you can’t personally participate, you’re still providing a robust benefit for your team. 

Conclusion 

CHOICE arrangements open the door for businesses of all sizes to offer health benefits in a flexible way. While the rules governing CHOICE limit which business owners can participate in this type of health benefit, there are ways to work around these limits. You can use tax deductions or spousal coverage to take care of your own insurance, while still reaping the advantages of a CHOICE for your staff.

You also have the option to leverage solutions like Vitable Health’s care-backed CHOICE. With this benefit, you ensure that you’re truly supporting your team’s health and creating a way for you to access everyday care yourself. 

If you’re an employer or broker looking to implement a CHOICE and have specific questions around owner eligibility nuances or how this benefit differs from traditional group health options, reach out to our team. We can help you set up a cost-effective, compliance-friendly plan and a healthier, happier workforce.

Sources

1. https://tax.thomsonreuters.com/blog/can-a-companys-owners-participate-in-its-hra/ 
2. https://www.healthcare.gov/small-businesses/learn-more/individual-coverage-hra/