A traditional, employer-funded Health Reimbursement Arrangement is a self-insured medical reimbursement plan, so it has to satisfy the nondiscrimination rules in Section 105(h) of the Internal Revenue Code. Those HRA nondiscrimination rules come down to two tests: an eligibility test that asks whether enough of the workforce can participate, and a benefits test that asks whether everyone who participates gets the same deal. If a plan fails either one, it doesn’t collapse. The rank-and-file keep their tax-free reimbursements. The highly compensated participants pick up the cost, with their reimbursements reclassified as taxable wages.
Which HRAs Section 105(h) Covers
Section 105(h) applies to self-insured medical reimbursement plans. A traditional HRA, where the employer reimburses employees directly for medical expenses instead of buying insurance, is self-insured by definition and must pass both tests.
Two other HRA designs sit outside the 105(h) framework. An Individual Coverage HRA (ICHRA) uses a class-based nondiscrimination system in federal regulations. A Qualified Small Employer HRA (QSEHRA) has its own “same terms” standard under a different section of the tax code. Both are covered further down.
Fully insured group health plans are not currently subject to nondiscrimination testing. The Affordable Care Act tried to extend 105(h)-style rules to those plans, but the IRS indefinitely delayed enforcement through Notice 2011-1, and that delay is still in effect.
Who Counts as a Highly Compensated Individual
The people at risk when a plan fails are called highly compensated individuals. Section 105(h)(5) defines three overlapping categories, and falling into any one of them is enough.
- The five highest-paid officers of the company, regardless of title or department.
- Anyone who owns more than 10% of the company’s stock by value. Constructive ownership under Section 318 pulls in shares held by a spouse, children, grandchildren, or parents, along with shares held through partnerships and certain trusts.
- The top 25% of all employees ranked by compensation, after removing the workers who can be excluded from the eligibility math.
This definition is specific to Section 105(h). It’s a different group from the “highly compensated employee” tested under Section 414(q) for retirement plans, which uses a $160,000 compensation threshold for 2026. Don’t mix the two.
The Eligibility Test
The eligibility test asks whether the plan covers a broad enough slice of the workforce. Under Section 105(h)(3), a self-insured HRA passes if it meets any one of three benchmarks:
- The plan benefits at least 70% of all employees, after permitted exclusions.
- At least 70% of employees are eligible for the plan, and at least 80% of those eligible employees actually benefit from it.
- The plan covers a classification of employees that the IRS finds nondiscriminatory in favor of highly compensated individuals under a facts-and-circumstances review.
These percentages are calculated after removing several categories of workers the statute lets employers set aside.1Office of the Law Revision Counsel. 26 US Code 105 – Amounts Received Under Accident and Health Plans
Workers You Can Leave Out of the Math
The statute permits excluding:
- Employees who have not completed three years of service
- Employees under age 25
- Part-time or seasonal employees
- Employees covered by a collective bargaining agreement where health benefits were the subject of good-faith bargaining
- Nonresident aliens with no U.S.-source earned income from the employer
These carve-outs let employers focus the compliance calculation on the permanent, full-time workforce.1Office of the Law Revision Counsel. 26 US Code 105 – Amounts Received Under Accident and Health Plans
Part-time doesn’t have a single statutory hour threshold. The Treasury regulations set a two-tier rule. An employee may be treated as part-time if the person customarily works fewer than 35 hours per week and other employees doing similar work for the same employer work substantially more hours. Anyone customarily working fewer than 25 hours per week can always be excluded as part-time, whatever comparable schedules look like.2eCFR. 26 CFR 1.105-11 – Self-Insured Medical Reimbursement Plan
The Benefits Test
Passing eligibility isn’t enough. Under Section 105(h)(4), every benefit available to a highly compensated individual has to be available on the same terms to every other participant.1Office of the Law Revision Counsel. 26 US Code 105 – Amounts Received Under Accident and Health Plans
The plan must be nondiscriminatory on paper and in practice. A written document that caps reimbursements at $5,000 for executives and $2,000 for everyone else fails on its face. A plan with a uniform $5,000 cap that routinely processes executive claims faster or approves a wider range of expenses for them fails in operation.
The Treasury regulations make the uniformity requirement explicit. Any maximum reimbursement attributable to employer contributions must be the same for all participants and their dependents, and it cannot vary with age or years of service.3eCFR. 26 CFR 1.105-11 – Self-Insured Medical Reimbursement Plan Dependent benefits follow the same rule. If a vice president can get reimbursed for a spouse’s dental work, so can a warehouse clerk.
What Happens When a Plan Fails
The tax hit lands only on the highly compensated. Rank-and-file employees keep their reimbursements tax-free. The highly compensated participants have to include their “excess reimbursements” in gross income for the year.4GovInfo. 26 USC 105 – Amounts Received Under Accident and Health Plans
How the taxable amount is calculated depends on which test the plan failed.
A Discriminatory Benefit
If a specific benefit is available only to highly compensated individuals and not to other participants, the entire reimbursement for that benefit is taxable income for the highly compensated person who received it. No proration. Every dollar becomes wages.4GovInfo. 26 USC 105 – Amounts Received Under Accident and Health Plans
An Eligibility Failure
When the plan fails the eligibility test but no particular benefit is limited to highly compensated participants, the excess reimbursement is calculated with a formula. Multiply the total amount reimbursed to the highly compensated individual during the plan year by a fraction: the numerator is the total reimbursed to all highly compensated participants, and the denominator is the total reimbursed to all employees. The product is the taxable portion.4GovInfo. 26 USC 105 – Amounts Received Under Accident and Health Plans
How the Amount Gets Reported
Excess reimbursements go into the standard wage boxes on the individual’s Form W-2 (Boxes 1, 3, and 5). The IRS has said these amounts should not be reported using Box 12, Code DD, which is reserved for the aggregate cost of employer-sponsored health coverage.5Internal Revenue Service. Form W-2 Reporting of Employer-Sponsored Health Coverage Employers need to track reimbursement totals for every participant across the plan year to compute the right taxable amount at year-end.
ICHRA Nondiscrimination: Employee Classes
An Individual Coverage HRA doesn’t use the 105(h) tests. Because employees must enroll in individual market insurance, the arrangement is treated as integrated with insured coverage rather than as a standalone self-insured plan. Federal regulations replace 105(h) with a class-based system.
Employers may split their workforce into recognized classes and offer different ICHRA contributions to different classes. The regulations list 11 permitted class categories: full-time employees, part-time employees, salaried employees, hourly employees, employees in a particular geographic rating area, seasonal employees, employees covered by a collective bargaining agreement, employees in a waiting period, nonresident aliens with no U.S.-based income, temporary staffing employees, and any combination of two or more of these categories.6eCFR. 29 CFR 2590.702-2 – Special Rule Allowing Integration of Individual Coverage Health Reimbursement Arrangements
Within a class, the ICHRA must be offered on the same terms. The contribution can vary only with the employee’s age or number of family members, following the age curve used in the individual insurance market (a maximum 3-to-1 ratio between oldest and youngest workers). Contributions can rise with age to offset higher premiums. They can’t fall with age.
Minimum Class Sizes
When an employer offers a traditional group health plan to one class and an ICHRA to another, the ICHRA class has to meet a minimum size. The thresholds apply to the class getting the ICHRA:
- Fewer than 100 employees total: the ICHRA class must have at least 10 employees.
- 100 to 200 employees total: the class must be at least 10% of the total employee count.
- More than 200 employees total: the class must have at least 20 employees.
Classes defined as new hires or as employees in a waiting period aren’t subject to these minimums. If an employer offers ICHRAs to everyone and no group plan at all, the minimum class size rules don’t apply.
QSEHRA Nondiscrimination: Same Terms
A Qualified Small Employer HRA is available only to employers that are not applicable large employers (generally, fewer than 50 full-time equivalent employees) and that don’t offer any group health plan.7Office of the Law Revision Counsel. 26 US Code 9831 – General Exceptions The nondiscrimination standard is simpler than either 105(h) or the ICHRA class system: the arrangement must be provided on the same terms to all eligible employees.
Only two variables can change the dollar amount an employee receives. The employer may vary the permitted benefit based on the employee’s age (or the age of family members) and based on the number of family members covered. When using those variations, the calculation must be tied to a single baseline insurance policy that qualifies as minimum essential coverage and is available for purchase by at least one employee. Beyond those two factors, every eligible employee gets the same access.
Differences in actual reimbursements from employees submitting different expenses don’t violate the same-terms rule, and neither does letting unused amounts carry over year to year. A QSEHRA that offers a choice between two benefit levels, or that limits eligibility to a single employer within a controlled group, does violate it.
For 2026, the maximum annual QSEHRA reimbursement is $6,450 for self-only coverage and $13,100 for family coverage. The caps are indexed to inflation and adjusted each year by the IRS.
Staying Compliant Through the Year
Passing the tests once isn’t the end of the job. Run the eligibility and benefits tests at least annually. Employee counts, compensation rankings, and participation data shift, so most compliance teams calculate at the start of the plan year and verify again before year-end.
The plan document is the first line of defense in any IRS review. A document that clearly states uniform reimbursement limits, consistent eligibility rules, and identical benefits for all participants makes the benefits test straightforward. A document that on its face creates tiered benefits or links reimbursements to compensation fails before a single claim is processed. Fixing a plan document is easy. Fixing a year of discriminatory payouts already out the door is not.
Welfare benefit plans covering 100 or more participants at the start of the plan year generally have to file Form 5500 with the Department of Labor. Smaller welfare plans that are unfunded or fully insured are exempt.8U.S. Department of Labor. 2025 Instructions for Form 5500 Annual Return/Report of Employee Benefit Plan Most traditional HRAs are self-insured (unfunded in ERISA terms), so whether Form 5500 applies turns on participant count and plan structure.