Beyond group health insurance: understanding your options with Section 105 plans

 In Financial News

While many recognize the necessity of health insurance, small business owners often find the cost of group health plans prohibitively expensive. Yet, offering health benefits is crucial for attracting and retaining talented employees. Fortunately, there are some lesser-known, tax-advantaged solutions that allow small employers to provide health benefits. 

Section 105 Health Reimbursement Arrangements (HRAs) are not health insurance plans, but they provide a way for employers to reimburse employees for medical expenses, including insurance premiums. Before the introduction of HRAs, employers were unable to reimburse individual health coverage premiums directly. With HRAs, employees purchase their own insurance, often through a health insurance marketplace, and employers reimburse the associated healthcare costs. These reimbursements are tax-deductible for the employer and tax-free for the employees, not affecting their adjusted gross income. 

This article will focus on two HRA models available to small employers: Individual Coverage HRAs (ICHRAs) and Qualified Small Employer HRAs (QSEHRAs). These level the playing field with traditional group insurance plans by avoiding many associated expenses and complexities. 

How do Section 105 plans generally work? 

The principle behind Section 105 plans is relatively straightforward. Employers set a monetary allowance for each employee for covered medical expenses. Any expenses detailed in IRS Publication 502 can qualify; however, employers can limit reimbursable expenses at their discretion. 

Employees purchase their own health insurance and provide proof to the employer that they have minimum essential coverage. As employees incur eligible healthcare costs, they submit proof of these expenses to their employer, often through a third-party administrator or benefits management software. The employer then reimburses these costs, typically on a monthly basis, up to the established allowance.

Benefits of Section 105 plans

Section 105 plans offer many benefits for both employers and employees in terms of savings, flexibility, and control. 

  • Tax savings: reimbursements are excluded from employees’ gross income, and employers can deduct them as business expenses. 

  • Cost savings: employers establish their business’s HRA allowance levels, avoiding insurance premium markups. 

  • Flexibility: employers can customize health benefits to align with budgetary needs. With some plans, employers can also set varying eligibility and reimbursement levels for different classes of employees. This customization also extends to choosing which medical expenses are eligible for reimbursement. 

  • Compatibility: Section 105 plans can work with existing health savings accounts (HSAs), and some QSEHRAs can be coordinated with spousal job-based health insurance. 

  • Control: employers maintain ownership of the funds, and any unused funds revert to the employer if an employee leaves the company. 

General rules for Section 105 plans

Section 105 plans must adhere to various federal regulations, including those set by the IRS, ERISA, HIPAA, ACA, and other relevant state and federal laws. Please note that relevant laws vary based on plan type and employer size, but generally speaking, these are some rules to keep in mind: 

  • Plan documents: the IRS mandates that written plan documents outline eligible expenses, employer contributions, and other plan specifics.

  • Employer funding: Section 105 plans are funded solely by the employer and not through employee salary deductions. 

  • Reimbursements: employees must substantiate each claimed healthcare expense with proper documentation, such as receipts and doctor’s notes. Both employers and employees should save relevant supporting documents for ten years.

  • Non-discrimination: plans must not discriminate in favor of highly compensated individuals with respect to eligibility or benefits. 

  • HIPAA compliance: as health plans, Section 105 plans must comply with HIPAA privacy rules to protect personal health information. 

  • COBRA: for employers with 20 or more employees, COBRA continuation coverage must be offered. Terminated employees must have the option to continue using the plan for a period of 18 or 36 months, but they can be charged up to 102% of their allowance if COBRA is elected. 

  • Summary plan descriptions: ERISA requires every welfare plan, including Section 105 plans, to provide a summary plan description to each participant. 

  • ACA research fees: employers are responsible for paying Patient-Center Outcomes Research Institute (PCORI) fees annually via Form 720. The fees are $3.22 per covered participant and are generally paid through the Electronic Federal Tax Payment System (EFTPS) in the second quarter. 

  • Notices: employers must provide 60 days advanced notice to participants before making material modifications to the plan. 

Again, this is a brief overview of some regulations that could apply to a Section 105 HRA. However, the applicable rules differ based on various factors, so it’s always wise to seek guidance from an expert advisor to ensure you’re familiar with all laws that could impact your plan. 

Can self-employed business owners participate in an HRA?

Employers must have at least one W2 employee to participate in a Section 105 HRA. The ability of self-employed business owners to participate in ICHRAs or QSEHRAs hinges on their employment status within the business and the business structure itself. 

C-corporation owners can participate in HRAs as employees of the corporation since a C-corp is a separate legal entity from its owners. Although S-corp owners can be W2 employees, they are generally not eligible to participate in HRAs if they own more than 2% of the company’s shares. Partners and sole proprietors are not eligible for HRAs because they are not considered W2 employees. 

Most self-employed business owners who don’t qualify for a Section 105 HRA can still deduct health insurance premiums and may be able to deduct other medical expenses if they itemize and the expenses exceed 7.5% of their adjusted gross income; however, this method may not reap as many benefits as an HRA.

For some self-employed individuals, a viable workaround is to employ their spouse as a W2 employee. The spouse must actively work in the business, and their compensation can include HRA benefits along with regular wages, though HRA benefits should not be the sole form of compensation. This arrangement requires careful documentation, including job descriptions and timesheets, to substantiate the employment and compensation structure. 

It’s also important to consult with a tax professional regarding ownership attribution rules. In certain cases, these rules may consider a spouse an owner by association, potentially affecting their eligibility to participate in the HRA. 

Let’s consider a hypothetical scenario to illustrate how a Section 105 HRA can be used in a small, family-owned LLC:

John Doe is the sole owner of an LLC, which he operates without other employees. He hires his wife as a part-time W2 employee to handle invoicing and bookkeeping for the business. His wife, Jane Doe, earns roughly $8,000 in wages, and $6,000 is allocated through an HRA for Jane to use for medical expenses, including insurance premiums. The total compensation of $14,000 is fully deductible for the LLC, and the $6,000 allocated through the ICHRA is not included in Jane’s gross income. 

Specific rules and differences between ICHRAs and QSEHRAs


ICHRAs are available to employers of any size, and reimbursement allowances can be tailored to different employee classes. For instance, you might specify that full-time employees are eligible for an allowance of $1,000 per month, part-time employees are eligible for $500 per month, and seasonal employees are not eligible for coverage. 

ICHRAs do not have annual reimbursement caps aside from what the employer establishes, and unused funds can be rolled over without limitation. 


QSEHRAs are designed for businesses with fewer than 50 full-time employees. They reimburse qualifying medical expenses much like an ICHRA, but there are annual contribution caps. For 2024, the annual contribution limit is $6,150 for self-only coverage and $12,450 for family coverage. Unused funds can be rolled over, though the rollover amount cannot exceed the annual maximum limits. 

All full-time employees must be eligible for this plan, but employers can choose whether the plan will be available to part-time employees. Unlike ICHRAs, QSEHRAs require uniform allowance contributions across employees, differing only by family size. So employers can provide a greater allowance for family HRAs than self-only HRAs, but they cannot vary allowances based on employee classes. 

Navigating the choice

Choosing the right Section 105 plan requires a careful assessment of your business needs and associated regulations. Generally, ICHRAs are preferable if you require flexibility in contribution limits or if your business employs more than 50 employees. However, the flexibility of ICHRAs comes with the need for more complex administration due to variable benefit levels across different employee classes. Employers looking for a simpler, more straightforward plan might prefer QSEHRAs. 

Section 105 plans require careful attention and management. Misunderstanding eligibility rules and failing to maintain proper documentation can lead to serious compliance issues. It’s crucial to consult with legal advisors or HR professionals to ensure your plan adheres to all applicable laws. 

If you’re a small business owner considering a Healthcare Reimbursement Plan, it’s important to assess all of your options. Our expert advisors can help you determine the most optimal way to account for your healthcare spending and explore the benefits a Section 105 plan may offer for your business. For more information, please contact our office.

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