Tax Code 105: Spouse HRA Plan Setup and Reimbursement Rules

A Section 105 HRA for a spouse lets a sole proprietor turn the family’s medical bills into a fully deductible business expense. The owner hires their spouse as a genuine employee, adopts a written health reimbursement arrangement as a fringe benefit, and reimburses the spouse tax-free for medical costs incurred by the employee, the employee’s spouse (the owner), dependents, and children under 27. The business deducts every dollar on Schedule C, cutting income tax and self-employment tax, while the reimbursed spouse pays no tax on the money.¹

Compare that to the alternative. A personal medical deduction on Schedule A only counts costs above 7.5% of adjusted gross income and never touches self-employment tax. Most families never clear the threshold at all.

Why the Owner Cannot Just Cover Themselves

Section 105(g) says a self-employed individual is not treated as an employee for purposes of the exclusion.¹ A sole proprietor who writes themselves a health reimbursement plan gets nothing; the money is just taxable income.

The spouse route is the workaround. Section 105(b) allows the plan to reimburse medical expenses for the employee’s spouse, dependents, and children under age 27.¹ Because the owner is the employee-spouse’s spouse, the owner’s own bills are covered. The business deducts the reimbursement as an ordinary employee benefit cost.

Making the Spouse a Real Employee

This is where most plans fail under audit. The IRS scrutinizes spouse-employee arrangements more closely than any other family employment situation, and the burden sits on the business owner to prove the job is real. A title on paper with no actual work will lose the entire deduction.

Four things carry the most weight:

Real duties the business needs, such as bookkeeping, phones, inventory, or scheduling. Vague labels like “administrative support” invite trouble.
Contemporaneous timesheets or work logs showing when the spouse worked and what they did. This is the single most useful piece of evidence in an audit.
Compensation proportional to the work, including the value of health benefits. There are no fixed IRS numbers for what counts as reasonable; courts look at training, experience, hours, responsibilities, and what comparable businesses pay.²
Payment from the business bank account, not a joint personal account. Reimbursements flow the same way.

The Shellito Tax Court case is the cautionary example. A farmer’s wife had done the same tasks for 19 years without pay, listed her occupation as “housewife” on the joint return, and was paid from the couple’s joint checking account. The Tax Court ruled she was not a true employee because the payments produced no economic benefit separate from what she already had access to. The Tenth Circuit later reversed, but the years of litigation are exactly what a small business owner wants to avoid.

The Written Plan Document

A formal written plan must exist before the first medical expense is incurred. Any expense that predates the plan’s effective date is not eligible for tax-free reimbursement, and backdating does not work. The IRS has disallowed deductions where documentation was created after the fact.

The document should identify the employer and the covered employee, state the effective date, cap the annual reimbursement amount, describe eligible expenses (generally by reference to Section 213(d)), lay out how the employee submits claims and how the employer pays them, and spell out how the plan can be amended or terminated. Third-party administrators and tax professionals sell pre-drafted templates in the $200 to $250 range. Whether you use a template or draft your own, sign and date it before the plan year begins, and give the employee-spouse a copy of the summary terms.

What the Plan Can Reimburse

Section 213(d) sets the scope: costs for diagnosing, treating, or preventing disease, transportation essential to care, long-term care services, and health insurance premiums, including Medicare Part B.³ IRS Publication 502 lists specifics.⁴

In practice, that covers:

Individual or family health insurance premiums, long-term care insurance premiums, and Medicare supplemental premiums.
Deductibles, copays, and coinsurance from any insurance the family carries.
Dental work, orthodontia, eye exams, glasses, and contacts.
Prescription medications, prescribed medical equipment, and supplies.
Chiropractic care, physical therapy, mental health counseling, and similar services.

Only expenses that insurance has not already paid are eligible. The plan can reimburse for the employee-spouse, the owner (as the employee’s spouse), dependents, and any of the employee’s children who have not yet turned 27 by the end of the tax year.¹

The ACA One-Participant Exception

This is the compliance point that carries the biggest downside if ignored. Failing to meet group health plan requirements can trigger a $100 per day per affected individual excise tax, which runs to $36,500 per year for a single covered person.⁵

After the Affordable Care Act, standalone HRAs were generally treated as noncompliant group health plans. IRS Notice 2013-54 explained that an HRA cannot simply reimburse individual market premiums on its own; it must either be integrated with a compliant group health plan or fit inside a specific exception.⁶

The exception that saves the spouse-employee model is the one-participant rule: ACA market reform provisions do not apply to plans with fewer than two participants who are current employees.⁷ If the spouse is the only current employee covered, the plan has one participant, even though it reimburses the whole family. The moment the business hires a non-family employee and covers them under the same plan, the exception disappears and full ACA compliance kicks in. At that point, a Qualified Small Employer HRA or an Individual Coverage HRA becomes the path forward.⁸

Running the Plan Day to Day

The employee-spouse pays medical bills out of pocket first, then submits a reimbursement request to the business. Each request should include the receipt, invoice, or explanation of benefits showing what insurance paid and what the patient owed. The business writes a reimbursement check from the business account.

This paper trail is not formality. Revenue Ruling 2005-24 holds that reimbursements are excludable under Section 105(b) only when they actually reimburse specific medical expenses. If the employee would receive the money whether or not any medical expense was incurred, the arrangement fails and every dollar becomes taxable.⁹ Lump-sum “health benefit” payments do not work.

Keep a plan-year file with every request, its supporting documents, and a copy of each check or bank transfer. Do not commingle the reimbursements with wages or run them through a joint personal account.

How It Shows Up on the Tax Return

On the sole proprietor’s Schedule C, reimbursements come off as an employee benefit expense, reducing both income tax and self-employment tax on the business’s net profit.³

For the employee-spouse, the reimbursements are excluded from gross income under Section 105(b) and do not appear as wages on the W-2.¹ The spouse’s actual wages for the work performed still go on a W-2 and remain subject to income tax withholding, Social Security, and Medicare. A spouse employed by a sole proprietor is exempt from federal unemployment (FUTA) tax.¹⁰

Self-insured plans, including these single-employee HRAs, owe a Patient-Centered Outcomes Research Institute (PCORI) fee. For plan years ending between October 2025 and September 2026, the rate is $3.84 per covered life, reported on Form 720 and due July 31 of the year following the plan year’s end.¹¹ For a family of four, that is about $15 a year. Small, but required.

When Your Business Structure Changes the Answer

This strategy is built for sole proprietors. Other structures work differently.

C-corporation owners are already employees of the corporation and can participate in the company’s health plan directly, without any spouse workaround. The corporation deducts the cost; the owner-employee excludes the reimbursements.

S-corporation shareholders who own more than 2% are treated like partners for fringe benefit purposes. Health and accident insurance premiums paid on their behalf are deductible by the S-corporation but must be reported as wages on the shareholder-employee’s W-2, subject to income tax withholding.⁷ The shareholder can then claim the self-employed health insurance deduction on the personal return, but the tax-free Section 105(b) reimbursement mechanism is generally unavailable. The one-participant ACA exception still applies when only family employees are covered.

Partnerships work similarly: partners are not employees for Section 105 purposes. A partner’s spouse could potentially be hired as an employee, but the arrangement invites additional scrutiny and warrants a review with a tax professional before you put it in place.

1
Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans
2
Internal Revenue Service. Wage Compensation for S Corporation Officers
3
Office of the Law Revision Counsel. 26 USC 213 – Medical, Dental, Etc., Expenses
4
Internal Revenue Service. Publication 502 – Medical and Dental Expenses
5
Office of the Law Revision Counsel. 26 USC 4980D – Failure to Meet Certain Group Health Plan Requirements
6
Internal Revenue Service. Notice 2013-54
7
Internal Revenue Service. S Corporation Compensation and Medical Insurance Issues
8
HealthCare.gov. Individual Coverage Health Reimbursement Arrangements
9
Internal Revenue Service. Rev. Rul. 2005-24
10
Internal Revenue Service. Married Couples in Business
11
Internal Revenue Service. Patient Centered Outcomes Research Trust Fund Fee – Questions and Answers