An executive medical reimbursement plan is an employer-funded arrangement that pays the out-of-pocket healthcare costs, deductibles, co-insurance, and services the group plan doesn’t cover, for a selected group of employees, usually senior leaders. Done right, the reimbursements are tax-free to the executive and deductible by the employer. Done wrong, they turn into taxable wages, trigger payroll taxes, and can expose the company to a $100-per-day excise tax per affected individual. The structure decisions that separate those outcomes are narrow, and most of them happen before the first claim is ever paid.
Why the Plan Has to Wrap Around Group Coverage
The plan sits on top of the company’s primary group health insurance. The group plan pays first. Whatever it leaves behind, a deductible, a co-pay, an excluded service, gets submitted to the reimbursement plan, which pays the balance.
That wrap-around design is not a preference. A standalone reimbursement arrangement is treated as a group health plan on its own, and because it caps benefits at whatever dollar figure the employer sets, it violates the Affordable Care Act’s prohibition on annual dollar limits. The excise tax for that failure runs $100 per day per affected individual under IRC Section 4980D.1Office of the Law Revision Counsel. 26 U.S. Code 4980D – Failure to Meet Certain Group Health Plan Requirements For a plan covering five executives, that’s $500 a day, more than $180,000 a year. Integrating with ACA-compliant group coverage sidesteps the problem entirely.
Self-Insured or Fully Insured: The Decision That Drives Everything
The single biggest structural choice is whether the plan is self-insured or fully insured, because that choice determines which nondiscrimination rules apply.
In a self-insured plan, the employer pays claims out of its own funds as they come in. It’s cheaper in low-claim years and gives the company control over design, but it exposes the employer to unpredictable cost swings. Many self-insured plans buy stop-loss insurance to cap that exposure. The catch: IRC Section 105(h) imposes strict nondiscrimination testing on self-insured plans, and an executive-only plan will fail it.
In a fully insured plan, the employer buys a policy from a third-party insurer, which bears the risk in exchange for fixed premiums. Section 105(h) does not apply. The ACA added a parallel nondiscrimination rule for fully insured plans under Section 2716, but the IRS has never finalized regulations to enforce it, so that rule is effectively dormant.
That gap is why fully insured supplemental policies are the workhorse structure for executive-only medical benefits. A fully insured plan can currently limit eligibility to a handful of executives and keep its tax-favored status. If the IRS ever finalizes regulations under Section 2716, that advantage disappears.
Who Counts as a Highly Compensated Individual
For self-insured plans, the nondiscrimination rules pivot on a specific statutory definition. You’re a highly compensated individual if you fall into any of three categories:2Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans
- One of the five highest-paid officers of the company, regardless of title.
- An owner of more than 10% of the employer’s stock value, applying the constructive ownership rules of Section 318.
- Among the highest-paid 25% of all employees, excluding certain workers left out of the calculation.
The third category is broader than employers usually expect. It isn’t limited to people with executive titles. A well-paid specialist or individual contributor can land in the top quarter and become subject to the same rules that apply to the C-suite.
What a Self-Insured Plan Has to Pass
A self-insured plan has to clear two tests to keep its tax-favored status: an eligibility test and a benefits test.2Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans
The eligibility test offers three alternatives. The plan can benefit 70% or more of all employees. Or, if at least 70% of employees are eligible, the plan passes as long as 80% or more of those eligible actually participate. Or the plan can cover employees under a classification the IRS doesn’t consider discriminatory in favor of highly compensated individuals.2Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans
Certain workers can be excluded from the testing pool: employees with fewer than three years of service, employees under age 25, part-time and seasonal workers, employees covered by a collective bargaining agreement that includes health benefits, and nonresident aliens with no U.S.-source income.2Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans Those exclusions can shrink the pool substantially.
The benefits test is harder. Every benefit available to a highly compensated participant must also be available to all other participants. A higher reimbursement cap for executives, a shorter waiting period, or an expense category the rank-and-file can’t use will sink the test.2Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans It’s a design test, not a results test. A plan that offers $50,000 in annual reimbursement to executives and $10,000 to everyone else fails on its face.
Tax Treatment When the Plan Complies
When the plan passes both tests, or is fully insured and not subject to them, reimbursements are excluded from the employee’s gross income under Section 105(b).2Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans They’re also excluded from wages for FICA purposes under IRC Section 3121(a)(2), so neither side owes Social Security or Medicare tax on the amounts.3Office of the Law Revision Counsel. 26 USC 3121 – Definitions On the employer side, the payments are deductible business expenses under IRC Section 162(a).4Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses
The reimbursed expenses themselves have to qualify as medical care under IRC Section 213(d), which covers amounts paid for the diagnosis, treatment, or prevention of disease.5Office of the Law Revision Counsel. 26 U.S. Code 213 – Medical, Dental, Etc., Expenses Deductibles, co-pays, prescription drugs, orthodontics, mental health care, vision correction, and physical therapy all fall within that definition; the plan document decides which of those the plan actually reimburses.
What Happens When a Self-Insured Plan Fails Testing
Failing nondiscrimination testing doesn’t invalidate the plan. It changes the tax treatment only for highly compensated individuals. Some or all of their reimbursements become “excess reimbursements” that get pulled into gross income.2Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans Rank-and-file employees are unaffected.
How much becomes taxable depends on the type of failure. If a benefit is offered exclusively to highly compensated individuals, the entire reimbursement for that discriminatory benefit is taxable to the executive who received it. If the failure is on the eligibility side, the taxable amount is calculated with a pro-rata formula: the individual’s reimbursement is multiplied by the fraction of total plan reimbursements that went to all highly compensated individuals.6eCFR. 26 CFR 1.105-11 – Self-Insured Medical Reimbursement Plan
The reclassified amounts land on Form W-2 as wages. That triggers income tax at the executive’s marginal rate and creates employer payroll tax obligations that wouldn’t exist under a compliant plan. Failing the tests doesn’t save the company money; it converts an efficient benefit into an expensive one, often years after the fact, when an audit surfaces the issue and interest and penalties are added on top.
HSA Compatibility
Executives enrolled in a high-deductible health plan who want to contribute to a health savings account need to look at this closely. A general-purpose reimbursement plan that pays medical costs before the HDHP deductible is met is treated by the IRS as “other coverage” and disqualifies the executive from HSA contributions.
Two workarounds exist. The reimbursement plan can be structured as a limited-purpose arrangement covering only dental, vision, and preventive care, which doesn’t overlap with the HDHP deductible. Or it can be designed as a post-deductible arrangement that only reimburses expenses incurred after the HDHP’s minimum deductible is satisfied. Either approach preserves HSA eligibility, but both need careful drafting in the plan document.
ERISA Administration You Can’t Skip
These plans are welfare benefit plans under ERISA, which brings administrative requirements employers routinely miss because the plans cover so few people that nobody thinks to create formal paperwork.
Every participant needs a Summary Plan Description, provided at no charge, explaining benefits, eligibility, claims procedures, and appeal rights in plain language. If the plan changes, participants get either an updated SPD or a summary of material modifications.7U.S. Department of Labor. Plan Information
COBRA applies too. Employers with 20 or more employees must offer continuation coverage when an executive loses eligibility because of termination, a reduction in hours, or retirement.8U.S. Department of Labor. Continuation of Health Coverage (COBRA) The former executive can elect to continue coverage by paying up to 102% of the plan’s full cost. Because the reimbursement plan is a group health plan under federal law, COBRA applies regardless of how few people participate.
Structures Employers Actually Use
Given the rules, three approaches dominate.
The most common is a fully insured supplemental policy purchased from a carrier and offered only to executives. Section 105(h) doesn’t apply, Section 2716 enforcement is suspended, and the reimbursements stay tax-free. The employer pays premiums, the insurer takes the risk.
Some employers want a self-insured design for cost or flexibility reasons and simply accept that the plan will fail testing. The reimbursements become taxable to the executives, and the employer usually grosses up compensation to offset the tax. It costs more than a compliant plan, but it gives the company full design control without an insurer in the middle.
A third option is the Individual Coverage HRA, created by 2019 federal regulations. An ICHRA lets employers offer different HRA amounts to different classes of employees, with permitted classes including salaried versus non-salaried and full-time versus part-time workers. Everyone within the same class has to receive the same terms, and participants must be enrolled in individual health insurance. An ICHRA can achieve some targeting without the same Section 105(h) exposure, though the interplay between ICHRAs and Section 105(h) is still an evolving area of IRS guidance.
Before committing to any self-insured executive-only design, the safer path is to price out a fully insured structure or talk with a benefits attorney about an ICHRA. The savings from self-insuring rarely survive the tax reclassification once an audit catches it.