A Health Reimbursement Arrangement works like this: your employer sets up an account, decides how much you can draw from it each year, and reimburses you tax-free when you submit receipts for eligible medical expenses. Only the employer puts money in. You never fund it from your paycheck. The reimbursements are excluded from your gross income under Internal Revenue Code Sections 105 and 106, and the employer deducts the contributions as a business expense.1Internal Revenue Service. Notice 2002-45 – Health Reimbursement Arrangements That is the entire tax mechanic behind how a Health Reimbursement Arrangement works.
The Basic Mechanics
The employer establishes a written plan, sets an annual dollar allowance for each eligible employee, and defines which medical costs the plan will cover. You incur an eligible expense, submit a claim with documentation, and the employer (or a third-party administrator) reviews it. If it qualifies under the plan terms, you get reimbursed. That reimbursement runs through payroll as a nontaxable payment or arrives as a separate check or direct deposit.
The employer controls almost every design choice. That includes the annual allowance, the eligible expense list, whether unused balances roll into the following year, and whether rollovers are capped or unlimited. Some plans zero out at year end. Others let balances accumulate for years. The plan document dictates all of it, which is why two employees at two different companies can have HRAs that behave nothing alike.
One rule is not up to the employer: HRAs must be 100% employer-funded. Any arrangement that takes money from employees through salary reductions is not a valid HRA. That single requirement is what separates HRAs from FSAs (which accept pretax salary deductions) and HSAs (which accept contributions from both sides).
The Types of HRAs
How an HRA works in practice depends on which type your employer offers. Federal rules recognize several, each with its own eligibility rules, contribution limits, and interaction with other coverage.
Individual Coverage HRA (ICHRA)
An ICHRA lets an employer of any size reimburse you for individual health insurance premiums and other qualified medical expenses instead of offering a traditional group plan.2HealthCare.gov. Individual Coverage Health Reimbursement Arrangements To get reimbursed, you must be enrolled in individual health coverage or Medicare.3Centers for Medicare and Medicaid Services. Individual Coverage Health Reimbursement Arrangements: Policy and Application Overview There is no federal cap on the employer’s annual contribution. An employer cannot offer an ICHRA and a traditional group plan to the same class of employees.
Qualified Small Employer HRA (QSEHRA)
A QSEHRA is available only to businesses with fewer than 50 full-time employees that do not offer any group health plan.4HealthCare.gov. Health Reimbursement Arrangements (HRAs) for Small Employers The IRS caps annual contributions. For 2026, the ceilings are $6,450 for self-only coverage and $13,100 for family coverage. All full-time employees must be offered the same terms, though the reimbursement amount can vary by age and family size. Funds become available monthly rather than as a year-start lump sum, and the annual limit prorates for employees who become eligible mid-year.
Integrated HRA
An Integrated HRA sits on top of a traditional group health plan and helps you cover the out-of-pocket costs the group plan leaves behind, such as deductibles and copayments. Because the group plan handles the core coverage, this HRA acts as a supplemental layer. No statutory contribution cap applies.
Excepted Benefit HRA (EBHRA)
An EBHRA reimburses expenses outside the main group plan, typically dental, vision, and short-term limited-duration insurance premiums. For plan years beginning in 2026, the annual contribution ceiling is $2,200.5Internal Revenue Service. Rev. Proc. 2025-19 You do not need individual health coverage to participate, and it can be offered alongside a group health plan.
Who Can and Cannot Participate
Only common-law employees can participate in an HRA. The IRS excludes several categories of business owners from their own company’s plan: sole proprietors, partners in partnerships, and anyone owning more than 2% of an S-corporation. Section 105(g) of the Internal Revenue Code treats self-employed individuals as falling outside the definition of “employee” for these purposes.6Office of the Law Revision Counsel. 26 U.S. Code 105 – Amounts Received Under Accident and Health Plans The 2% S-corp rule follows from the IRS treating those shareholders the same as self-employed individuals for fringe benefit purposes.
Because HRAs are self-insured health plans, they also have to satisfy nondiscrimination rules under Section 105(h). The rules prevent plans from being tilted toward highly compensated individuals (the five highest-paid officers, more-than-10% shareholders, and the top 25% of employees by pay).7Internal Revenue Service. Self-Insured Medical Reimbursement Plans – Memorandum When a plan fails testing, the consequence is narrow: the highly compensated individuals lose tax-free treatment on their reimbursements. Everyone else keeps it. ICHRAs use a different framework built around employee classes (full-time, part-time, salaried, hourly, seasonal, geographic rating area, and others). Within any single class, everyone has to be offered the same terms.
What Expenses Qualify
IRS Publication 502 sets the outer boundary of what can be reimbursed tax-free.8Internal Revenue Service. Publication 502 – Medical and Dental Expenses The list is wide: doctor and hospital bills, prescription drugs, lab work and diagnostic tests, eye exams, contact lenses, dental fillings, orthodontics, and mental health services all qualify. Over-the-counter medications used to treat a medical condition are eligible; the CARES Act permanently restored OTC drug eligibility without a prescription starting in 2020.
Publication 502 is the ceiling, not the floor. Employers can narrow it. A plan might reimburse only insurance premiums. Another might cover out-of-pocket costs but exclude premiums. Some restrict reimbursement to dental and vision only. The plan document spells out the boundaries, and the plan document is what governs a claim. Read it before you incur a large expense expecting to be paid back.
How an HRA Coordinates With an HSA
This is where employees get into trouble. If you have a high-deductible health plan and want to contribute to a Health Savings Account, a general-purpose HRA will disqualify you, because the HRA provides first-dollar coverage that conflicts with the HDHP’s high-deductible structure. For 2026, HSA eligibility requires an HDHP with an annual deductible of at least $1,700 for self-only coverage or $3,400 for family coverage.5Internal Revenue Service. Rev. Proc. 2025-19
Two HRA designs preserve HSA eligibility:
- A limited-purpose HRA reimburses only dental and vision expenses, so it does not undercut the HDHP deductible.
- A post-deductible HRA reimburses nothing until you have met the HDHP minimum deductible, then kicks in for qualifying costs.
Some employers combine both, running a limited-purpose HRA from day one that converts to a general-purpose HRA once the HDHP deductible is satisfied. If your employer offers an HRA and an HDHP together, ask which design applies before you contribute to an HSA. Getting it wrong makes your HSA contributions impermissible and creates a tax problem larger than any reimbursement gain.
What an ICHRA Does to Your Premium Tax Credit
An ICHRA offer changes your Marketplace subsidy math. If you accept the ICHRA, you cannot receive a premium tax credit at all, no matter your income.9HealthCare.gov. Individual Coverage HRAs You can only claim the credit if the ICHRA is considered unaffordable and you opt out of it. Affordability turns on whether your share of the lowest-cost silver plan in your area, after the ICHRA reimbursement is applied, exceeds a set percentage of household income. If the ICHRA is affordable under that test, you are ineligible for the credit even if you decline the offer.
Lower-income employees are most affected, because a premium tax credit can be worth more than the ICHRA allowance. Compare the two before deciding. Your employer must send a written notice before the plan year explaining the ICHRA and telling you to check your premium tax credit eligibility.
What Happens When You Leave
Because the employer owns the HRA, any unused balance stays with the business when you go. You cannot cash it out. If the employer has 20 or more employees, COBRA continuation coverage applies to the HRA the same way it does to a group health plan.10U.S. Department of Labor. Continuation of Health Coverage (COBRA) Electing COBRA lets you keep submitting claims against your HRA balance for up to 18 months, and longer for certain qualifying events such as disability or divorce. The employer can charge up to 102% of the applicable premium for that continued coverage.
When the HRA is integrated with a group plan, the employer can require you to elect COBRA for both together rather than the HRA alone. Each qualified beneficiary, including a spouse and dependents, has an independent right to elect or decline HRA COBRA coverage.
Setting Up the Plan
An employer launching an HRA has to lock in several design choices up front: which type of HRA to offer, the annual contribution, which employee classes are eligible, which expenses qualify, and whether unused funds carry over. Mid-year changes are generally off the table.
ERISA requires two written documents. The Plan Document contains the legal terms governing the arrangement. The Summary Plan Description explains the plan to employees in plain language, and it must be provided to participants at no cost.11U.S. Department of Labor. Plan Information Both are required.
For an ICHRA, written notice must go to eligible employees at least 90 days before the plan year begins.3Centers for Medicare and Medicaid Services. Individual Coverage Health Reimbursement Arrangements: Policy and Application Overview QSEHRAs carry the same 90-day requirement. Employees who become eligible mid-year get the notice on their eligibility date. The notice explains the reimbursement amount and, for ICHRAs, warns employees to evaluate premium tax credit eligibility before accepting.
Compliance Consequences
The penalty structure explains why the design rules get taken seriously. An HRA that fails to comply with applicable federal requirements, whether through improper funding, coverage mandate violations, or nondiscrimination failures, can trigger the Section 4980D excise tax of $100 per day for each affected employee. A company with 10 affected employees is looking at $1,000 per day, or $365,000 over a year. This is also the penalty that applies when a standalone HRA violates the Affordable Care Act’s market reform provisions, which is why freestanding HRAs outside the four approved categories (ICHRA, QSEHRA, EBHRA, or integrated with a group plan) are effectively prohibited.
Recordkeeping is what protects the plan under audit. Every claim, receipt, and reimbursement transaction has to be documented and retained. If the employer cannot prove an expense was eligible, the IRS can reclassify the reimbursement as taxable income. Most employers use a third-party administrator for exactly this reason: the administrator processes claims, holds the medical documentation, and passes only the minimum information back to the employer.