A Medical Expense Reimbursement Plan (MERP) is the umbrella label for any employer-funded arrangement that reimburses workers for medical costs tax-free under Section 105 of the Internal Revenue Code. A Health Reimbursement Arrangement (HRA) is a specific, IRS-recognized type of MERP with its own rules on funding, rollovers, and substantiation. So when people compare a MERP vs an HRA, they are usually comparing a generic Section 105 reimbursement plan against the more structured HRA framework the IRS formalized in 2002. Every HRA is a MERP. Not every MERP is an HRA. The difference decides which compliance rules apply, how the plan gets reported, and whether owner-employees can participate at all.
What a MERP Actually Is
MERP is not a term defined in the tax code. It is industry shorthand for a self-insured medical reimbursement plan governed by Section 105(b).1Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans Under that statute, employer-paid reimbursements for medical care are excluded from an employee’s gross income, so long as the expenses qualify as “medical care” under Section 213(d): doctor visits, prescriptions, dental, vision, and health insurance premiums.2Office of the Law Revision Counsel. 26 USC 213 – Medical, Dental, Etc., Expenses
The Treasury regulations describe the mechanics: a self-insured medical reimbursement plan is a separate written plan that reimburses employee medical expenses and is not funded through an insurance policy from a licensed carrier.3eCFR. 26 CFR 1.105-11 – Self-Insured Medical Reimbursement Plan Because the employer pays claims from its own assets, it controls what to cover and how much to reimburse. The payments are deductible to the employer and tax-free to the employee.
When benefits professionals say “MERP,” they usually mean a standalone Section 105 plan that is not structured as a formal HRA. Some small businesses set one up as a simple reimbursement arrangement, skipping the rollover features, substantiation infrastructure, and regulatory apparatus that come with an HRA. The simplicity is real. So is the trade-off: no detailed IRS guidance to lean on if the arrangement is audited.
What an HRA Adds
An HRA is the specific type of MERP the IRS formally recognized in Notice 2002-45. Three rules define it.
First, funding must come exclusively from the employer. Employee salary-reduction contributions or any cafeteria plan mechanism are prohibited.4Internal Revenue Service. Notice 2002-45 – Health Reimbursement Arrangements That is what separates an HRA from a flexible spending account, where employees put in their own pre-tax dollars.
Second, every reimbursement must be individually substantiated as a medical expense. The arrangement cannot function as a cash bonus or provide any non-medical benefit. If any participant has the right to receive cash or a non-medical benefit under the plan, every distribution to every participant becomes taxable.4Internal Revenue Service. Notice 2002-45 – Health Reimbursement Arrangements The all-or-nothing consequence keeps HRA design narrowly focused.
Third, unused balances roll over. The employer sets a maximum dollar amount per coverage period, and any leftover balance carries forward. That is the feature most employees care about, and it distinguishes the HRA from use-it-or-lose-it accounts while still capping the employer’s annual exposure.
Where They Overlap and Where They Split
Both draw their tax-free treatment from Section 105, both require employer funding, and both reimburse the same universe of Section 213(d) medical expenses. For a small company reimbursing a few employees for out-of-pocket costs, a basic MERP and a basic HRA can look nearly identical in day-to-day operation.
The differences show up in the regulatory detail:
- Rollover. HRAs explicitly permit unused balances to carry forward. A standalone MERP has no standardized rollover unless the plan document creates one.
- IRS safe harbor. HRAs operate under detailed IRS guidance — Notice 2002-45 and the later rules for QSEHRA and ICHRA — which gives employers a clear compliance path. A generic MERP has no equivalent framework, leaving more room for design errors.
- Subtypes. Congress and the IRS have created specific HRA variants with their own eligibility rules and contribution caps. A MERP has no such subtypes.
- Substantiation. Both require documentation, but HRA guidance requires that each expense be independently verified before reimbursement. A loosely administered MERP that skips substantiation risks losing tax-free status entirely.
Most employers setting up a new medical reimbursement arrangement today pick a recognized HRA type rather than a generic MERP, because the regulatory clarity reduces audit risk. The situations where a standalone MERP still makes sense usually involve business structures where no HRA variant fits cleanly, such as certain partnerships or sole proprietorships.
The HRA Types an Employer Actually Picks From
If you go the HRA route, you are choosing among three main designs.
Qualified Small Employer HRA
The QSEHRA is available only to employers with fewer than 50 full-time equivalent employees that do not offer a group health plan. For 2026, the IRS caps annual contributions at $6,450 for self-only coverage and $13,100 for family coverage.5Internal Revenue Service. General Instructions for Forms W-2 and W-3 – 2026 The employer must offer the same terms to every eligible employee, though amounts can vary based on age and family status.
Employees need individual health insurance that provides minimum essential coverage to receive tax-free reimbursements. QSEHRA funds are made available monthly rather than as a year-start lump sum, and mid-year hires get a prorated amount. The employer reports the total permitted benefit — not the amount actually used — on each W-2 in Box 12 with Code FF.5Internal Revenue Service. General Instructions for Forms W-2 and W-3 – 2026
Individual Coverage HRA
The ICHRA works for employers of any size and has no federal contribution cap. The employer sets whatever dollar amount it wants for the plan year.6HealthCare.gov. Individual Coverage Health Reimbursement Arrangements Employees must carry their own individual health policy, whether from the marketplace or elsewhere.
Contributions can vary by employee class, including full-time versus part-time, salaried versus hourly, and work location. An employer cannot offer both a traditional group plan and an ICHRA to the same class of employees, but can split the workforce, for example by putting new hires after a certain date on the ICHRA while keeping existing employees on the group plan.
For an ICHRA offer to be considered “affordable” in 2026, the employee’s remaining cost for the lowest-priced Silver plan in their area, after the HRA reimbursement, must be less than 9.96% of one-twelfth of yearly household income.6HealthCare.gov. Individual Coverage Health Reimbursement Arrangements That threshold matters because an affordable ICHRA offer disqualifies the employee and their household from marketplace premium tax credits. An unaffordable offer can be declined in favor of the credit, but the employee cannot receive both.
Integrated HRA
An integrated HRA pairs with a traditional group health plan from the same employer. The HRA reimburses out-of-pocket costs the group plan does not cover, such as deductibles, copays, and coinsurance. There is no federal contribution cap. The employer decides how much to make available. This design is most common at larger employers offering a high-deductible group plan while softening the deductible for employees.
Tax Treatment by Business Structure
The tax benefit depends heavily on how the business is organized. For owner-operators, this is often the deciding factor.
C corporation owner-employees are treated the same as any other employee. They participate in the HRA, receive reimbursements tax-free, and the company deducts the payments as a business expense.
S corporation shareholders who own more than 2% get a much worse deal. The IRS treats them as self-employed under Section 1372, which means they cannot participate in an HRA or receive tax-free reimbursements under Section 105(b), and they are explicitly barred from QSEHRAs.7Internal Revenue Service. S Corporation Compensation and Medical Insurance Issues The S corp can still reimburse health insurance premiums for these shareholders, but the reimbursement gets added to W-2 wages (subject to income tax, not self-employment tax). The shareholder can then claim the self-employed health insurance deduction on their personal return, which partially offsets the tax hit without replicating the full tax-free benefit available to C corp owners and regular employees.
Sole proprietors and partners face the same exclusion. They are not “employees” under Section 105, so they cannot receive tax-free reimbursements through any HRA. This is one scenario where a standalone MERP through a spouse’s employment sometimes gets considered, though those arrangements need careful structuring to survive IRS scrutiny.
Nondiscrimination Rules Apply to Both
Self-insured medical reimbursement plans, including HRAs, must satisfy the nondiscrimination requirements of Section 105(h). The rules prevent employers from funneling tax-free benefits to executives while offering nothing to the rank and file.1Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans
There are two tests. The eligibility test requires that enough non-highly-compensated employees benefit; one way to pass is to cover at least 70% of all employees. The benefits test requires that highly compensated participants not receive richer reimbursement terms than everyone else.3eCFR. 26 CFR 1.105-11 – Self-Insured Medical Reimbursement Plan
The consequence of failing falls only on the highly compensated. If the plan fails the benefits test, the full amount of any discriminatory benefit received by a highly compensated individual becomes taxable. If it fails the eligibility test, a ratio formula determines the taxable portion. Non-highly-compensated employees keep their tax-free treatment either way.1Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans
QSEHRAs have a built-in workaround. Because they must offer the same terms to every eligible employee, they satisfy the nondiscrimination rules by design.
Compliance Load
Either structure requires a formal written plan document. It is not optional paperwork; it is the legal foundation the IRS will look for in an audit. The document must include the employer’s legal entity name, tax ID, plan year, eligibility rules, the maximum annual reimbursement, and which expenses are covered.
Employers must also give a Summary Plan Description to every eligible employee. Federal regulations require the SPD to describe eligibility, benefits, and the procedures for filing and appealing claims, written in language the average participant can understand.8eCFR. 29 CFR 2520.102-3 – Contents of Summary Plan Description Plan records must be kept for at least six years after the filing date of any report based on them, per ERISA Section 107.
Beyond the plan document, HRAs are classified as group health plans and trigger several federal filings:
- Form 5500. Employee benefit plans covered by ERISA file annually with the Department of Labor through EFAST2. Plans with 100 or more participants use the standard Form 5500; smaller plans use Form 5500-SF. Late filing carries IRS penalties of $250 per day, up to $150,000 per return, and the DOL can add penalties on top. Self-administered plans with fewer than 100 participants that meet certain conditions may be exempt.9Internal Revenue Service. Form 5500 Corner
- PCORI fee. Employers sponsoring a self-insured health plan, including an HRA, pay the Patient-Centered Outcomes Research Institute fee annually on Form 720, due July 31. For plan years ending between October 1, 2025 and September 30, 2026, the fee is $3.84 per covered individual.10Internal Revenue Service. Patient-Centered Outcomes Research Trust Fund Fee: Questions and Answers
- W-2 Code FF. QSEHRAs specifically require reporting the total permitted benefit (not actual reimbursements) in W-2 Box 12 with Code FF. ICHRAs and integrated HRAs do not use Code FF and generally have no Box 12 reporting.5Internal Revenue Service. General Instructions for Forms W-2 and W-3 – 2026
- HIPAA. A group health plan with fewer than 50 participants administered solely by the employer that established it is not a HIPAA-covered entity. QSEHRAs almost always qualify. Larger plans or those using third-party administrators may need a Business Associate Agreement and HIPAA procedures.
Choosing Between Them
For most employers, the practical choice is not “MERP or HRA” but “which HRA.” A recognized HRA type comes with a regulatory roadmap that a generic MERP does not, and the IRS guidance on QSEHRAs, ICHRAs, and integrated HRAs is detailed enough that a properly drafted plan can operate with predictable results.
Small employers without a group plan tend to land on a QSEHRA, capped at $6,450 self-only and $13,100 family for 2026. Employers of any size that want to move away from a group plan while offering a defined benefit toward individual coverage tend to land on an ICHRA. Larger employers that keep a group plan use an integrated HRA to absorb deductibles and cost-sharing.
A standalone MERP remains a viable design in narrow cases, mostly where the business structure locks the owner out of participating in a formal HRA and a Section 105 arrangement can be built around a spouse-employee. Outside those situations, the HRA framework is what the IRS has spent two decades building guidance around, and the compliance case for using it is stronger than the case for going without.