The tax benefits of an ICHRA run in both directions: an employer deducts every dollar it reimburses and pays no payroll tax on those amounts, and the employee receives the money free of federal income tax and FICA as long as they hold qualifying individual health coverage. Unlike a QSEHRA, an Individual Coverage Health Reimbursement Arrangement carries no federal cap on contributions, and a properly designed plan also satisfies the ACA employer mandate for large employers.
What Employers Deduct and Avoid in Payroll Tax
Every dollar reimbursed through an ICHRA is a deductible business expense under Internal Revenue Code Section 162, the same provision that covers wages, rent, and other ordinary operating costs.1eCFR. 26 CFR 1.162-1 – Business Expenses The deduction reduces taxable income dollar-for-dollar whether the business is a corporation or a pass-through entity.
The bigger recurring saving is on payroll taxes. Employers normally pay 6.2% for Social Security and 1.45% for Medicare on every dollar of wages, a combined 7.65% FICA contribution.2Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates ICHRA reimbursements are not wages, so no FICA is owed on them. A company offering $500 per month to 20 employees saves roughly $9,180 a year in employer-side FICA alone, on top of the income tax deduction.
Federal Unemployment Tax Act obligations shrink as well. FUTA runs 6.0% on the first $7,000 of each employee’s annual earnings, reduced to an effective 0.6% for most employers after the state credit.3Internal Revenue Service. Topic No. 759, Form 940 Employers Annual Federal Unemployment Tax Return ICHRA contributions sit outside the FUTA wage base and avoid this tax entirely. The same benefit dollar routed through an ICHRA costs the company less than the same dollar paid as a wage increase.
No Federal Contribution Cap
QSEHRAs have statutory annual limits. ICHRAs do not.4HealthCare.gov. Individual Coverage Health Reimbursement Arrangements An employer can offer $200 per month to one class of workers and $1,500 per month to another, and can vary amounts within a class by employee age (within a 3:1 ratio) and by the number of dependents covered. The deduction and payroll-tax treatment apply regardless of the amount.
What Employees Keep Tax-Free
On the employee side, ICHRA reimbursements are excluded from gross income under Internal Revenue Code Section 106, which treats employer-provided coverage under an accident or health plan as non-taxable compensation.5Office of the Law Revision Counsel. 26 USC 106 – Contributions by Employer to Accident and Health Plans An employee who receives $400 per month in ICHRA reimbursements keeps the full $400. If the same $400 arrived as wages, federal income tax and payroll withholding would take a cut first.
The exclusion also applies to the employee’s share of FICA. Workers normally pay 6.2% for Social Security and 1.45% for Medicare on wages.6Social Security Administration. Contribution and Benefit Base ICHRA reimbursements bypass those deductions. On $6,000 a year through an ICHRA, that is roughly $459 the employee keeps compared with receiving the same amount as taxable pay.
One hard condition governs everything above. The employee must be enrolled in individual health coverage that qualifies as minimum essential coverage, typically a plan bought through the marketplace, directly from an insurer, or Medicare. If the employee drops coverage or never enrolls, reimbursements for that period become taxable as ordinary income. Employees newly offered an ICHRA qualify for a Special Enrollment Period on the marketplace and have 60 days from the offer to pick up a plan.7HealthCare.gov. Getting Health Coverage Outside Open Enrollment
Which Expenses Qualify
ICHRA funds can reimburse more than premiums. Employers choose whether to allow reimbursement for out-of-pocket medical costs that qualify under Section 213(d), a category that covers doctor visits, prescription drugs, dental work, vision care, mental health services, and medical equipment.8Internal Revenue Service. Publication 502 – Medical and Dental Expenses Expenses that are merely beneficial to general health, like vitamins or gym memberships, do not qualify. The plan document controls which categories are reimbursable.
ACA Employer Mandate Compliance
Applicable Large Employers with 50 or more full-time equivalent employees must offer minimum essential coverage to at least 95% of their full-time workforce or face penalties under Section 4980H.9Office of the Law Revision Counsel. 26 USC 4980H – Shared Responsibility for Employers Regarding Health Coverage A properly structured ICHRA satisfies that offer requirement. The penalty for failing to offer any coverage runs about $3,340 per full-time employee in 2026 (minus the first 30), and the penalty for offering coverage that is not affordable runs about $5,010 per affected employee.
To stay in the safe harbor, the ICHRA must be affordable: the employee’s remaining cost for the lowest-cost silver plan in their area, after subtracting the ICHRA allowance, must not exceed 9.96% of household income for the 2026 plan year.10Internal Revenue Service. Revenue Procedure 2025-25 CMS publishes an annual look-up table so employers can test their offers against local silver-plan premiums without collecting each employee’s income.11Centers for Medicare & Medicaid Services. Employer Initiatives The same contributions that generate the deduction and payroll-tax savings are what keep the company compliant.
How an ICHRA Offer Affects Premium Tax Credits
Being offered an ICHRA, even one the employee turns down, changes eligibility for the Premium Tax Credit under Section 36B.12Office of the Law Revision Counsel. 26 USC 36B – Refundable Credit for Coverage Under a Qualified Health Plan If the offer is affordable under the 9.96% test for 2026, the employee is disqualified from marketplace subsidies.10Internal Revenue Service. Revenue Procedure 2025-25
Employees who receive an unaffordable offer can opt out and claim the Premium Tax Credit instead, but the decision must be made before the plan year starts.13Centers for Medicare & Medicaid Services. Individual Coverage Health Reimbursement Arrangements – Policy and Application Overview Accepting the ICHRA, even an unaffordable one, forfeits the credit for those months. Federal law does not allow both the tax-free ICHRA reimbursement and the Premium Tax Credit for the same coverage period. For lower-income employees with modest offers, the marketplace subsidy can be worth more than the employer’s contribution, so it is worth running the numbers.
Pairing an ICHRA with an HSA
An employee can contribute to a Health Savings Account while using an ICHRA if the ICHRA is designed to be HSA-compatible. A standard ICHRA that reimburses all out-of-pocket medical expenses, including costs within the plan’s deductible, counts as impermissible “other coverage” and blocks HSA contributions. To preserve HSA eligibility, the ICHRA must limit reimbursements to insurance premiums only, or to premiums plus expenses incurred after the deductible is met.
The employee also needs an HSA-qualified high deductible health plan. For 2026, that means a minimum annual deductible of $1,700 for self-only coverage or $3,400 for family coverage, and maximum out-of-pocket costs of $8,500 or $17,000 respectively.14Internal Revenue Service. Revenue Procedure 2025-19 Starting January 1, 2026, the One Big Beautiful Bill Act treats all bronze and catastrophic plans, on or off the exchange, as HSA-compatible regardless of whether they meet the traditional HDHP definition.15Internal Revenue Service. Treasury, IRS Provide Guidance on New Tax Benefits for Health Savings Account Participants Under the One Big Beautiful Bill
With both accounts in play, the tax treatment stacks. The ICHRA pays premiums tax-free. The HSA shelters contributions from income and payroll tax up to $4,400 for self-only or $8,750 for family coverage in 2026, and qualified withdrawals come out tax-free. The employee owns the HSA and keeps it after leaving the job, while unused ICHRA funds stay with the employer.
What You Have to Document to Keep the Tax Treatment
The tax-free treatment is conditional on paperwork. Every medical expense submitted for reimbursement must be substantiated with an itemized bill, receipt, or explanation of benefits showing the expense qualifies under the plan. The employer or a third-party administrator reviews and approves each claim.
Employees must also verify they have qualifying coverage, both at enrollment and with each reimbursement request. That can be an insurance card, another third-party document, or a signed attestation naming the insurance provider, the coverage start date, and confirming minimum essential coverage. Employers may rely on attestations unless they have actual knowledge that the employee is uninsured. Reimbursing someone the employer knows lacks coverage puts the entire plan’s tax treatment at risk.
Applicable Large Employers report ICHRA offers on Form 1095-C, which shows the offer, the months, and the employee’s required monthly contribution used for the affordability test.16Internal Revenue Service. About Form 1095-C, Employer-Provided Health Insurance Offer and Coverage The cost of coverage, including ICHRA contributions, also appears in Box 12 of the W-2 under Code DD as informational reporting that does not make the benefit taxable.17Internal Revenue Service. Form W-2 Reporting of Employer-Sponsored Health Coverage Check that the amounts on your 1095-C and W-2 match the allowance you were actually offered, because mismatches can complicate Premium Tax Credit reconciliation.