Are HRA Reimbursements Taxable? Qualified Expenses and Payroll Tax

Reimbursements from a Health Reimbursement Arrangement are generally not taxable. When the plan meets IRS requirements and pays you back for qualified medical care, the money is excluded from your gross income under Internal Revenue Code Sections 105 and 106, meaning no federal income tax and no payroll tax on the amount.¹² The tax-free treatment is conditional, though, and a handful of common situations can pull some or all of a reimbursement back into taxable income.

What Makes an HRA Reimbursement Tax-Free

Section 106 keeps the employer’s contribution out of your wages. Section 105(b) then keeps the actual reimbursement out of your income, provided it pays for medical care as defined in Section 213(d). IRS Publication 502 lists the qualifying expenses: doctor visits, prescriptions, hospital stays, dental care, and similar items.³

Three plan conditions carry that exclusion:

The employer funds the HRA entirely. Employees cannot contribute through salary reductions or payroll deductions. If employee money goes in, the arrangement loses its tax-free status.¹
Every reimbursement covers a qualified medical expense. Paying for anything else is taxable.
No participant has the right to cash out unused funds or receive any non-medical benefit. If even one person can take cash, every reimbursement to every participant that year becomes taxable, including the ones that went toward real medical costs.⁴

The cash-out rule is the one that surprises people. It is a plan-level test, not a per-person test. A design flaw that lets anyone convert HRA dollars to cash contaminates the whole plan for the year.

When HRA Reimbursements Become Taxable

Non-Qualified Expenses

If the HRA reimburses you for something that is not medical care under Section 213(d), that reimbursement is included in your gross income. And if the plan is written to allow non-medical reimbursements or cash payouts in the first place, IRS Notice 2002-45 treats all distributions to all participants as taxable for the entire tax year, not just the non-qualified amounts.⁴

Discrimination in Favor of Highly Paid Employees

An HRA is a self-insured medical reimbursement plan, so it has to satisfy the nondiscrimination rules in Section 105(h). The plan cannot favor highly compensated individuals in eligibility or benefits. A highly compensated individual for this purpose is one of the five highest-paid officers, an owner of more than 10% of the employer’s stock, or someone among the highest-paid 25% of all employees.²

If the plan fails the tests, the exclusion does not apply to reimbursements paid to those highly compensated individuals. Their reimbursements become taxable income. Everyone else keeps the tax-free treatment.²

Cash Payouts of Unused Balances

Some HRAs let unused funds roll into the next year, and rolled-over amounts keep their tax-free status as long as they can only be used for future qualified medical expenses.⁵ If a plan instead pays out unused balances as cash at year-end or on termination, it fails the medical-expense-only requirement and every distribution from the HRA that year is included in gross income. Plans that simply forfeit unused balances create no tax issue: you never received the money, so there is nothing to tax.

Payroll Tax and the Real Dollar Difference

The exclusion covers payroll tax as well as income tax. Section 3121 removes payments for medical or hospitalization expenses from the definition of “wages” for FICA purposes, so qualified HRA reimbursements are not subject to the 6.2% Social Security tax or the 1.45% Medicare tax, and the employer avoids its matching share too.⁶⁷

The difference is real money. In the 22% federal bracket, a $1,000 HRA reimbursement puts $1,000 in your pocket. The same $1,000 paid as a taxable bonus would drop to roughly $703 after federal income and payroll taxes.

How an HRA Affects Your Premium Tax Credit

If you buy Marketplace coverage and your employer also offers an Individual Coverage HRA (ICHRA) or a Qualified Small Employer HRA (QSEHRA), the HRA can change what you owe at tax time even though the reimbursements themselves stay tax-free. This is where surprise tax bills happen.

ICHRA

The IRS runs an affordability test. Your ICHRA is affordable if the remaining cost of the lowest-priced silver plan available to you, after subtracting the monthly HRA amount, is less than 9.96% of household income for the 2026 plan year.⁸ If the ICHRA is affordable, you cannot claim the Premium Tax Credit, whether you accept the HRA or opt out. Only an unaffordable ICHRA that you opt out of preserves your eligibility for the credit.⁹

QSEHRA

A QSEHRA reduces the credit rather than blocking it outright. If the QSEHRA is affordable for a given month, no PTC is allowed for that month. If it is unaffordable, you can still claim a PTC, but you must reduce it by the monthly permitted benefit amount, even if you did not use the QSEHRA.¹⁰ The Marketplace does not know about your QSEHRA when it sets your advance credit, so you have to adjust the advance payments down during the year. Otherwise the excess advance credit gets clawed back when you file.¹¹

How HRA Reimbursements Show Up on Your Tax Return

Qualified HRA reimbursements do not appear in Box 1 of your W-2, and you do not enter them anywhere on Form 1040. For a QSEHRA, your employer reports the total permitted benefit (not the amount you used) in Box 12 using Code FF. That figure is informational and does not increase your taxable income; it exists so the IRS can check your PTC math.¹²

An ICHRA has no Box 12 code. Instead, large employers report the ICHRA offer and its affordability on Form 1095-C using specific indicator codes (1L through 1S) that describe the type of offer.¹³

If you received advance PTC payments and were also offered an HRA, you have to reconcile the two on Form 8962. Write “QSEHRA” in the top margin of page 1 if that applies, so the IRS can follow your entries.¹⁰ Excess advance credit is repaid with your return; a shortfall is claimed as an additional credit.¹⁴

If a reimbursement was for something that does not qualify as medical care, that amount belongs in your gross income. Your employer may add it to your W-2 wages, or you may need to report it yourself if the error surfaces later. Check that the numbers on your W-2 match your HRA records each year.

Keep Your Receipts

Hold onto receipts, explanation-of-benefits statements, and HRA reimbursement records for at least three years after you file the return for that year. If unreported income ever exceeds 25% of the gross income shown on your return, the IRS has six years to assess additional tax, so six years of records gives you more room.¹⁵

Documentation matters more than usual if you also itemize medical expenses on Schedule A, because you cannot deduct anything the HRA already reimbursed. And if the IRS asks whether a reimbursement was for a qualified medical expense, the receipt is what keeps it tax-free.³

1
Office of the Law Revision Counsel. 26 USC 106 – Contributions by Employer to Accident and Health Plans
2
Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans
3
Internal Revenue Service. Publication 502 (2025), Medical and Dental Expenses
4
IRS.gov. Health Reimbursement Arrangements Notice 2002-45
5
Internal Revenue Service. Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans
6
Office of the Law Revision Counsel. 26 USC 3121 – Definitions
7
Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates
8
Internal Revenue Service. Rev. Proc. 2025-25
9
Internal Revenue Service. Instructions for Form 8962 (2025) – Who Can Take the PTC
10
Internal Revenue Service. Instructions for Form 8962 (2025) – Reminders
11
HealthCare.gov. Qualified Small Employer HRAs (QSEHRA)
12
Internal Revenue Service. General Instructions for Forms W-2 and W-3 (2026) – Code FF
13
Internal Revenue Service. Instructions for Forms 1094-C and 1095-C
14
Internal Revenue Service. Reconciling Your Advance Payments of the Premium Tax Credit
15
Internal Revenue Service. Topic No. 305, Recordkeeping