Can family members of an S-Corp owner participate in a HRA?

Title 26 of IRS Code states that spouses, children, grandchildren, and parents are all considered owners when one person has greater than 2% ownership of an S-Corp.

Owners establishing an HRA for their employees should always include themselves and their spouses in the HRA platform, although in some cases such Owners may not receive the same amount of tax benefits as non-owner employees.

Current or former employees may participate in a HRA and receive reimbursements 100% tax-free. Employees who are "Owners" (e.g. sole proprietors, partners, or S-Corp shareholders that own >2% of the company's shares) may use the HRA platform but may not receive the same amount of tax benefits as non-owners as explained herein.

S-Corp Owners may receive reimbursement from their companies for medical expenses, and they may use the HRA platform to receive and track these reimbursements. However, reimbursements made to Owners must be reported on the owners'/partners' wages (on their W-2 and 1040 forms) subject to federal income tax withholding. These reimbursements are exempt from Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) taxes, similar to profits passed through to the owner. Further, the cost of the reimbursements is a deductible expense to the business, reducing the taxable income of the business and, thus, reducing the taxable income of the owners/partners (because these are flow-through tax entities).

Note that sole proprietors and other self-employed individuals receive an above-the-line tax deduction for personal health insurance premiums. IRS Notice 2008-1 (see http://www.irs.gov/pub/irs-drop/n-08-01.pdf) clarified that S-Corp owners may only take the self-employed health insurance premium tax deduction (on Form 1040) if the S-Corp pays for or reimburses the owner for the premiums.