Section 105 HRA Plan: ICHRA, QSEHRA, and EBHRA Rules

A Section 105 HRA plan is an employer-funded health reimbursement arrangement that pays employees back, tax-free, for qualified medical expenses. The name comes from Section 105 of the Internal Revenue Code, which excludes those medical reimbursements from the employee’s taxable income while letting the employer deduct every dollar as a business expense. Done correctly, it is one of the most tax-efficient ways a business can help workers cover healthcare costs. Done without the paperwork, it collapses into taxable wages.

How the Tax Savings Actually Work

Section 105(a) starts with a general rule that employer payments through a health plan are taxable to the employee. Section 105(b) then carves out the reimbursements that matter here: amounts paid specifically for medical care are excluded from the employee’s gross income.¹ That exclusion is the whole engine. Qualifying reimbursements carry no federal income tax, no Social Security tax, and no Medicare tax for the employee.

On the employer side, every dollar paid out through the HRA is an ordinary business expense, deductible under Section 162.² The employer also avoids the payroll tax it would have owed on the same amount paid as wages.

One rule is absolute: only the employer funds the HRA. Employees cannot contribute their own money. The balance functions like a line of credit earmarked for medical expenses, not an account the employee owns. When the employee leaves, any remaining balance typically stays with the employer unless the plan says otherwise or COBRA applies.

What Expenses Qualify

The outer boundary comes from Section 213(d), which defines medical care to include diagnosis, treatment, and prevention of disease, along with insurance premiums covering those services.³ Employers do not have to cover that full range. Most plans narrow the list to categories like deductibles, copays, prescription drugs, or dental and vision care.

Over-the-counter medications and health products are eligible for reimbursement without a prescription, a change made permanent for HRAs by the CARES Act in 2020.⁴ Pain relievers, allergy medication, and first-aid supplies qualify if the plan document allows them.

Employers also decide what happens to unused funds. A carryover design lets unused allocations roll into the next plan year. A use-it-or-lose-it design forfeits the balance at year-end. Whichever approach the employer picks has to be written into the plan document before the plan year begins; changing course mid-year is not permitted.

Who Cannot Participate

Section 105 HRAs are for common-law employees only. Self-employed individuals, sole proprietors, partners in a partnership, and LLC members taxed as partners are all ineligible. Section 105(b) limits the income exclusion to employees, and the tax code does not treat self-employed people as their own employees for this purpose.

The same restriction catches S-corporation shareholders who own more than 2% of the company. The IRS treats them as self-employed for health benefit purposes, so HRA reimbursements they receive cannot be excluded under Section 105(b).⁵ This is a common trap for small business owners who set up an HRA expecting to participate alongside their staff. C-corporation shareholder-employees, by contrast, are common-law employees and can participate fully.

Setting Up the Written Plan Document

An HRA must be established through a formal written document. Federal regulations define a self-insured medical reimbursement plan as “a separate written plan for the benefit of employees which provides for reimbursement of employee medical expenses.”⁶ Without that written plan in place before benefits begin, the IRS can treat every reimbursement as taxable wages. That is the most direct way for a small employer to lose the entire tax benefit.

At a minimum the plan document should cover:

Eligibility rules, including which employees qualify and any waiting periods.
The maximum annual allowance per participant.
The specific categories of medical expenses the plan will reimburse.
The claims procedure for submitting and reviewing expenses.
The 12-month plan year used for tracking benefits.
The carryover or forfeiture policy for unused funds.

An authorized company representative must sign and date the document before the plan’s effective date. If the employer is subject to ERISA, which covers most private-sector employers, the plan must also produce and distribute a Summary Plan Description. New participants generally receive the SPD within 90 days of becoming covered; when a plan first becomes subject to ERISA, the SPD goes out within 120 days.

Failing to provide requested plan documents to a participant when required can expose the plan administrator to personal liability of up to $100 per day under ERISA’s enforcement provisions, with courts able to award additional relief.⁷

The Three Modern HRA Variations

In practice, “Section 105 HRA” today usually means one of three regulated designs. Each was built to fit a different employer situation and to comply with Affordable Care Act rules.

Individual Coverage HRA (ICHRA)

The ICHRA lets employers of any size reimburse employees tax-free for individual health insurance premiums and other medical expenses, in place of offering a traditional group plan.⁸ The employee must be enrolled in an individual health insurance policy, purchased on or off the Marketplace, to use the benefit. The employer cannot offer both a traditional group plan and an ICHRA to the same class of employees.

There is no cap on the employer contribution. Within an employee class, the allowance can vary by age and number of dependents, but age-based variation cannot exceed a 3-to-1 ratio between the oldest and youngest participants.⁸ Employers can segment their workforce into classes such as full-time versus part-time or salaried versus hourly, but classes cannot be drawn based on health status.

One point matters for employees: if your employer offers you an ICHRA, you generally cannot claim the Premium Tax Credit for Marketplace coverage unless the ICHRA is considered unaffordable and you opt out of it entirely.⁹ Affordability is measured by comparing the ICHRA allowance against the cost of the lowest-cost silver plan in the employee’s area. If the remaining cost after the allowance exceeds roughly 9% of household income, the offer is unaffordable and the employee can decline it and keep the Premium Tax Credit.

Qualified Small Employer HRA (QSEHRA)

The QSEHRA is for small businesses with fewer than 50 full-time equivalent employees that do not offer any group health plan.¹⁰ Unlike the ICHRA, the QSEHRA has statutory caps. For 2026, the maximum is $6,450 for self-only coverage and $13,100 for family coverage.¹¹ The limits are adjusted for inflation each year.

QSEHRA reimbursements are tax-free only if the employee maintains minimum essential coverage. An employee without qualifying insurance who receives QSEHRA payments must include them in taxable income. The QSEHRA amount also reduces any Premium Tax Credit the employee claims for Marketplace coverage, dollar for dollar.

Every eligible employee must receive a written notice at least 90 days before the start of each plan year.¹⁰ New hires receive the notice when they first become eligible. It must state the annual benefit amount and remind the employee to report the QSEHRA allowance to the Marketplace if they receive a Premium Tax Credit.

Excepted Benefit HRA (EBHRA)

The EBHRA is a smaller supplemental arrangement offered alongside a traditional group health plan. It reimburses items like dental, vision, copays, and short-term limited-duration insurance premiums. For plan years beginning in 2026, the maximum annual contribution is $2,200.¹²

The EBHRA must be offered in conjunction with traditional group health coverage, though employees do not have to actually enroll in the group plan to use the EBHRA.¹³ It cannot reimburse individual health insurance premiums or group plan premiums other than COBRA continuation coverage.

The HSA Compatibility Trap

Employers who offer both a high-deductible health plan and an HRA frequently run into trouble here. A standard HRA that reimburses general medical expenses before the employee satisfies the HDHP deductible counts as disqualifying coverage for HSA purposes.¹⁴ An employee covered by that kind of HRA cannot contribute to an HSA even if they are enrolled in a qualifying high-deductible plan.

Three HRA designs preserve HSA eligibility:

A post-deductible HRA that only reimburses expenses after the employee has met the statutory minimum HDHP deductible ($1,700 self-only or $3,400 family in 2026).¹⁴
A limited-purpose HRA that covers only dental and vision expenses, which count as permitted coverage.
A preventive-care-only HRA that mirrors the first-dollar preventive care HDHPs are already allowed to provide.

Getting this wrong is expensive. Employees who contribute to an HSA while covered by a disqualifying HRA face a 6% excise tax on the excess contributions for every year the money stays in the account. Employers designing an HRA alongside an HDHP need to specify the structure in the plan document before the plan year begins.

Nondiscrimination Testing

Self-insured HRAs must pass nondiscrimination tests under Section 105(h). The tests prevent employers from funneling disproportionate benefits to highly compensated individuals. There are two prongs: an eligibility test asking whether rank-and-file employees can participate on comparable terms to executives, and a benefits test asking whether highly compensated individuals receive richer reimbursements.¹⁵

A highly compensated individual for Section 105(h) purposes means any of the five highest-paid officers, any shareholder owning more than 10% of the company’s stock, or anyone in the top 25% of all employees by compensation.¹⁵ If the plan fails either test, only the highly compensated individuals lose their tax exclusion; their reimbursements become taxable income. Everyone else keeps the tax-free treatment.

ICHRAs have their own nondiscrimination framework built into the class rules, so the traditional 105(h) tests do not apply. QSEHRAs must be offered on the same terms to all eligible employees, which effectively satisfies nondiscrimination by design. Traditional 105(h) testing matters most for standard HRAs and EBHRAs offered alongside group coverage.

Substantiation, COBRA, and Privacy

Every reimbursement from any Section 105 HRA must be backed by documentation proving the expense qualifies. Acceptable proof includes an explanation of benefits from an insurance carrier or a detailed receipt showing the date of service, the type of service, and the amount the patient owes. A credit card statement or cancelled check alone does not qualify, because neither identifies what the payment was for. The administrator must also confirm the expense has not already been reimbursed by insurance, a flexible spending account, or another HRA. When substantiation breaks down across the plan, the IRS can retroactively reclassify all reimbursements as taxable wages.

Because an HRA is a group health plan, employers with 20 or more employees must offer COBRA continuation coverage when an employee has a qualifying event such as job loss, a reduction in hours, or divorce.¹⁶ The obligation extends to the HRA balance even if the employer also offers COBRA on its insured medical plan. The employer can charge a COBRA premium for the HRA benefit, calculated from past utilization or an actuarial estimate, plus up to 2% for administration.

Administering claims means handling receipts, diagnoses, and treatment descriptions that count as protected health information under HIPAA. The employer must adopt written privacy policies, designate a privacy official, and train any staff who touch participant medical data.¹⁷ The plan document must include a certification that the employer will not use HRA protected health information for employment decisions or other benefit plans. Many small employers delegate claims administration to a third party partly to keep employees’ medical details away from managers.

Annual Reporting and Fees

Running an HRA creates several annual filings that vary by plan type and size.

Employers offering a QSEHRA must report the total permitted benefit for each employee on Form W-2, in Box 12 with Code FF.¹¹ The reported figure is the benefit the employee was entitled to receive for the year, not the amount actually reimbursed. If the plan offered $6,000 and the employee claimed only $2,000, the W-2 still shows $6,000.

HRA sponsors must also pay the Patient-Centered Outcomes Research Institute (PCORI) fee annually on IRS Form 720. For plan years ending between October 2025 and September 2026, the fee is $3.84 per covered life.¹⁸ Form 720 is due by July 31 of the year following the plan year’s end.

If the HRA is subject to ERISA, the employer may also need to file Form 5500 with the Department of Labor. Plans covering 100 or more participants at the start of the plan year file as large plans and must include a financial audit. Smaller plans may qualify for simplified filing or an exemption if the plan is unfunded or fully insured.¹⁹ QSEHRAs are generally exempt from ERISA and therefore from Form 5500.

1
Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans
2
Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses
3
Office of the Law Revision Counsel. 26 USC 213 – Medical, Dental, Etc., Expenses
4
Internal Revenue Service. IRS Outlines Changes to Health Care Spending Available Under CARES Act
5
Internal Revenue Service. S Corporation Compensation and Medical Insurance Issues
6
eCFR. 26 CFR 1.105-11 – Self-Insured Medical Reimbursement Plan
7
Office of the Law Revision Counsel. 29 USC 1132 – Civil Enforcement
8
HealthCare.gov. Individual Coverage Health Reimbursement Arrangements
9
Internal Revenue Service. Updates to Questions and Answers About the Premium Tax Credit
10
HealthCare.gov. Health Reimbursement Arrangements (HRAs) for Small Employers
11
Internal Revenue Service. 2026 General Instructions for Forms W-2 and W-3
12
Internal Revenue Service. Revenue Procedure 2025-19 – Inflation Adjusted Items for HSAs and Excepted Benefit HRAs
13
CMS Agent and Broker FAQ. What Is an Excepted Benefit Health Reimbursement Arrangement
14
Internal Revenue Service. Expanded Availability of Health Savings Accounts Under the One, Big, Beautiful Bill Act
15
Internal Revenue Service. Section 105(h) Nondiscrimination Guidance
16
U.S. Department of Labor. Continuation of Health Coverage (COBRA)
17
U.S. Department of Health and Human Services. Summary of the HIPAA Privacy Rule
18
Internal Revenue Service. Patient Centered Outcomes Research Trust Fund Fee Questions and Answers
19
U.S. Department of Labor. 2024 Instructions for Form 5500