Section 105

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Introduction to Section 105

If you’ve been researching health benefits, chances are you’ve stumbled across the term Section 105 and wondered what on earth it means. Is it a tax loophole? A type of insurance? A retirement plan?

In plain English, Section 105 refers to Section 105 of the Internal Revenue Code, which allows employers to reimburse employees for medical expenses on a tax-free basis. That’s the foundation behind Health Reimbursement Arrangements (HRAs), including modern options like ICHRA and QSEHRA.

For small business owners, HR managers, and employees, understanding Section 105 is critical because it determines how health reimbursements are taxed, structured, and regulated. Let’s break it down step by step.

What Is Section 105?

Section 105 of the Internal Revenue Code governs employer-provided accident and health plans. The law allows:

• Employers to deduct reimbursements as a business expense
• Employees to receive reimbursements tax-free (if structured properly)
• Medical expenses defined under IRC Section 213(d) to qualify

The IRS outlines these rules in Publication 502 and Publication 969, both available at IRS.gov.

In short, Section 105 is what makes tax-free employer reimbursement of medical expenses legal.

Without it, employer-paid health benefits wouldn’t have the same tax advantages.

What Types of Expenses Qualify?

Under Section 105, reimbursements must be for qualified medical expenses as defined under IRC 213(d). These typically include:

• Health insurance premiums
• Doctor visits
• Prescription medications
• Hospital services
• Mental health treatment
• Dental and vision care
• Certain medical equipment

Not everything qualifies. Cosmetic procedures, for example, usually do not unless medically necessary.

This distinction matters. If an employer reimburses non-qualified expenses, those payments become taxable income to the employee.

How Section 105 Applies to Small Businesses

Now, here’s where it gets practical.

Small businesses don’t typically have massive HR departments or in-house compliance teams. Yet they still want to offer competitive benefits.

Section 105 allows them to:

1. Control costs by setting reimbursement limits
2. Avoid unpredictable group insurance premium hikes
3. Offer tax-advantaged benefits without sponsoring a traditional group plan

Instead of buying one group policy for everyone, an employer can establish a Section 105-compliant Health Reimbursement Arrangement (HRA). Employees then purchase individual health coverage, and the employer reimburses eligible expenses tax-free.

That flexibility is especially valuable for startups, remote teams, and companies with employees in multiple states.

Section 105 and HRAs

Most modern HRAs operate under Section 105 rules. The most common include:

• ICHRA (Individual Coverage HRA)
• QSEHRA (Qualified Small Employer HRA)
• Integrated HRAs (paired with group coverage)

Each must comply with IRS regulations, Affordable Care Act (ACA) requirements, and Department of Labor guidance.

For example:

• ICHRA was authorized in 2019 by federal regulation.
• Employees must have Minimum Essential Coverage (MEC) to receive tax-free reimbursements.
• Employers must follow formal plan document and notice requirements.

This isn’t a “handshake agreement” situation. Documentation and compliance matter.

Section 105 and Tax Advantages

Let’s talk money. Because that’s usually what sparks interest.

For Employers

Reimbursements under Section 105 are:

• 100% tax-deductible as a business expense
• Not subject to employer payroll taxes
• Predictable and controllable

Unlike traditional group insurance, where premiums can jump 15–20% in a renewal cycle, HRAs allow employers to set defined contribution amounts.

That cost control can make or break a small business budget.

For Employees

Qualified reimbursements are:

• Free from federal income tax
• Free from FICA (Social Security and Medicare taxes)
• Free from federal unemployment tax

That means a $500 reimbursement is truly $500 in value — not reduced by taxes.

However, employees must maintain qualifying health coverage. Without it, reimbursements may become taxable.

Compliance Considerations Under Section 105

Here’s the part that trips people up.

Section 105 plans must comply with multiple federal rules:

• IRS nondiscrimination requirements
• ACA market reform provisions
• ERISA plan document requirements
• HIPAA privacy standards

For example, standalone HRAs that don’t comply with ACA rules can trigger penalties of up to $100 per day per employee under Internal Revenue Code Section 4980D.

That’s not pocket change.

Proper plan design, documentation, and administration aren’t optional — they’re essential.

Nondiscrimination Rules

Section 105 includes nondiscrimination rules that prevent employers from favoring highly compensated employees.

If a plan disproportionately benefits owners or executives, reimbursements to those individuals may become taxable.

For small businesses with owner-employees, entity structure also matters:

• C-corporation owners can generally participate.
• More-than-2% S-corp shareholders face different tax treatment.
• Sole proprietors and partners are not considered employees under Section 105.

It’s crucial to align the benefit design with your business structure.

Section 105 vs. Traditional Group Insurance

Let’s compare apples to apples.

Traditional Group Plan:

• Employer selects one or two plan options
• Premiums increase annually
• Limited flexibility
• Heavy administrative load

Section 105-Based HRA:

• Employer sets reimbursement allowance
• Employees choose their own plans
• Cost control by design
• Reimburse only actual expenses

For employees, this means more choice. Someone with a family can choose robust coverage. A younger employee may select a high-deductible plan.

It’s personalization instead of one-size-fits-all.

What Employees Should Know About Section 105

Employees often worry: “Is this real insurance?”

It’s not insurance. It’s a reimbursement arrangement governed by Section 105.

That means:

• You buy your own health insurance plan.
• Your employer reimburses eligible expenses.
• You must submit proof of coverage and expenses.
• Reimbursements are tax-free if requirements are met.

Employees also need to understand how Marketplace premium tax credits interact with ICHRA:

• If the ICHRA is considered affordable under ACA rules, you generally cannot claim premium tax credits.
• If it’s unaffordable, you may decline the ICHRA and seek credits.

Affordability calculations are based on IRS guidance released annually.

Common Misconceptions About Section 105

Let’s clear up a few myths.

“It’s only for large companies.”Not true. Small employers often benefit the most.

“It’s risky or experimental.”Section 105 has existed for decades. Modern HRAs simply apply updated regulatory guidance.

“It’s too complicated.”It can be — if administered manually. But with the right platform, compliance and documentation can be automated.

“Employees won’t like it.”In practice, many employees appreciate having plan choice rather than being locked into a single group option.

Why Section 105 Matters More Than Ever

Healthcare costs aren’t slowing down. According to data from the Centers for Medicare & Medicaid Services (CMS.gov), national health expenditures continue to rise year over year.

Small businesses feel that pressure first.

Section 105 provides a lawful, IRS-backed structure that shifts health benefits from a fixed insurance model to a defined contribution approach.

Instead of asking, “How do we afford the group plan renewal?” employers can ask, “What budget works for us?”

That’s a meaningful shift in control.

Final Thoughts on Section 105 and SimplyHRA

Section 105 is the legal backbone that allows small businesses to reimburse medical expenses tax-free, control benefit costs, and give employees real choice. But compliance, documentation, and ongoing administration can be overwhelming without the right support. At SimplyHRA, we help small business owners, HR managers, and employees design and manage compliant ICHRA and HRA plans built on Section 105 rules — without the paperwork headaches. If you’d like guidance tailored to your company, email us at info@simplyhra.com or schedule a call at https://www.simplyhra.com/contact. Let’s build health benefits your team will actually love.

Section 105 Plan Design Strategies for Growing Companies

When small businesses first hear about Section 105, the focus is usually tax savings. Fair enough — that’s the obvious win. But where things get interesting is plan design.

Section 105 gives employers flexibility in how they structure reimbursements, provided they stay within IRS and ACA rules. That flexibility can be used strategically.

For example, employers can:

• Set different reimbursement amounts by employee class (as allowed under ICHRA regulations)
• Offer higher allowances to full-time employees than part-time employees
• Provide family-tiered reimbursements (self-only vs. family coverage)
• Cap annual reimbursements to maintain budget predictability

This isn’t random generosity. It’s thoughtful benefits architecture.

A growing startup might start with modest reimbursements in year one, then increase allowances as revenue stabilizes. Because Section 105 arrangements are employer-funded and defined-contribution in nature, you’re not locked into a carrier contract renewal cycle like traditional group insurance.

That adaptability is a competitive advantage.

Designing Around Employee Demographics

Here’s something many employers overlook: workforce demographics matter.

If your team is:

• Young and mostly single → Lower allowances may still provide meaningful support.
• Distributed across multiple states → Individual coverage flexibility becomes critical.
• Family-heavy → You may want higher family-tier reimbursement caps.
• Remote-first → Section 105-based HRAs eliminate network limitations tied to one regional group carrier.

Traditional group plans often struggle with geographic diversity. Section 105 reimbursement models remove that friction because employees shop locally for plans that fit their ZIP code.

Section 105 Documentation Requirements

Now let’s talk paperwork — because yes, there is some.

To be compliant under Section 105 and related federal laws, employers must maintain:

1. A formal written plan document
2. A Summary Plan Description (SPD) if subject to ERISA
3. Proper employee notices (especially for ICHRA)
4. Substantiation procedures for expenses
5. HIPAA-compliant privacy safeguards

The U.S. Department of Labor (dol.gov) requires ERISA-covered health plans to provide participants with plan information. Meanwhile, the IRS requires proper substantiation before reimbursements can be excluded from income.

This means:

• Employees must provide proof of Minimum Essential Coverage.
• Claims must be reviewed before reimbursement.
• Employers cannot simply give a taxable stipend and call it an HRA.

If documentation is missing, reimbursements may lose tax-advantaged status.

The Importance of Substantiation

Substantiation sounds technical, but it’s straightforward.

Before reimbursement, there must be documentation showing:

• The expense was incurred
• The amount
• The date of service
• That it qualifies under Section 213(d)

Self-attestation alone generally isn’t enough. IRS guidance has consistently required independent third-party verification for tax-free treatment.

This is where many DIY arrangements fall short. Without a compliant review process, what was intended to be a tax-free benefit can turn into taxable wages during an audit.

Section 105 and Payroll Integration

One area that deserves more attention is payroll coordination.

Although reimbursements under Section 105 are not subject to payroll taxes, they must still be tracked accurately. Employers need systems that:

• Separate taxable wages from non-taxable reimbursements
• Prevent duplicate payments
• Handle partial reimbursements properly
• Maintain clean audit trails

If reimbursements are added incorrectly to payroll, they may be accidentally taxed. On the flip side, failing to document them properly could create reporting inconsistencies.

Integrated systems — particularly those that sync with payroll providers — reduce these risks dramatically.

For small HR teams, automation isn’t a luxury. It’s risk management.

Section 105 in Mergers, Acquisitions, and Rapid Hiring

Small businesses don’t stay small forever — at least that’s the goal.

When companies merge, acquire another business, or scale quickly, benefits structures can get messy. Section 105-based HRAs can actually simplify transitions.

Here’s why:

• You’re not tied to one insurance carrier contract.
• New hires in different states can enroll in local individual plans.
• Reimbursement budgets can be standardized across expanding teams.
• There’s no need to negotiate new group underwriting rates.

If a company doubles in size within a year, the reimbursement model simply scales with headcount. The employer sets allowances; employees handle plan selection.

That separation of roles reduces administrative bottlenecks during growth phases.

Risk Management and Audit Readiness

Let’s address the elephant in the room: audits.

While most small businesses will never face a formal IRS or DOL audit of their health plan, compliance preparedness matters. Section 105 plans should be audit-ready at all times.

An audit-ready arrangement includes:

• Archived plan documents
• Signed employee acknowledgments
• Proof of coverage records
• Reimbursement logs
• Clear nondiscrimination analysis

Having these records organized demonstrates good-faith compliance if questions ever arise.

The IRS Small Business and Self-Employed division (irs.gov) emphasizes documentation as a cornerstone of compliance across all employee benefit arrangements. Health plans are no exception.

It’s far better to build compliance into the system from day one than scramble later.

Section 105 and Employee Retention

Benefits aren’t just about tax law — they’re about people.

Employees increasingly value portability and personalization. With a Section 105-compliant HRA:

• Employees own their individual insurance policy.
• Coverage isn’t tied to staying at one employer forever.
• They can select doctors and networks that suit their families.
• Life changes (marriage, relocation, new child) are easier to manage.

That sense of autonomy can increase perceived value of the benefit.

And here’s the kicker: employees often appreciate transparency. When they see a defined monthly allowance, they understand exactly what the company is contributing toward their healthcare.

Clarity builds trust.

State Law Considerations Under Section 105

While Section 105 is federal tax law, insurance regulation largely occurs at the state level.

That means:

• Individual insurance plan availability varies by state.
• Premium costs differ significantly by ZIP code.
• Some states have additional continuation coverage requirements.

Employers offering reimbursement-based benefits should remain aware of multi-state compliance implications, particularly if they have remote employees.

The good news? Because employees purchase individual coverage regulated in their own state, employers avoid navigating multiple state group insurance filings.

It’s a cleaner division of responsibility.

The Long-Term Outlook for Section 105 Arrangements

Healthcare reform conversations come and go. Political climates shift. But Section 105 has been part of the Internal Revenue Code for decades.

While specific HRA types have evolved — most notably with ICHRA regulations finalized in 2019 — the underlying tax framework remains firmly established.

For small businesses seeking stability, that matters.

Defined contribution health benefits built on Section 105 offer:

• Legal clarity
• Budget control
• Employee flexibility
• Scalable administration

It’s not a workaround. It’s embedded in federal tax law.

SimplyHRA and Smarter Section 105 Administration

Section 105 creates powerful opportunities for small businesses — but only if the plan is structured, documented, and administered correctly. That’s where SimplyHRA comes in. We help employers design compliant reimbursement plans, automate substantiation, integrate payroll, maintain audit-ready documentation, and provide employees with real-time support. If you’re ready to simplify Section 105 administration while giving your team flexible, tax-advantaged health benefits, email info@simplyhra.com or schedule a consultation at https://www.simplyhra.com/contact. Let’s make health benefits simpler, smarter, and built for your business.

Frequently Asked Questions (FAQs) about Section 105:

Q: Can a Section 105 plan reimburse expenses for employees’ spouses and dependents?

A: Yes. Section 105 allows reimbursements for qualified medical expenses incurred by an employee’s spouse and dependents, as defined under Internal Revenue Code Section 152. These reimbursements remain tax-free as long as the plan document permits dependent coverage and the expenses meet the definition under Section 213(d). Employers should clearly outline dependent eligibility in their written plan to avoid confusion.

Q: Are unused Section 105 funds carried over to the next year?

A: It depends on how the plan is designed. Unlike HSAs, Section 105 HRAs are entirely employer-funded and employer-controlled. Employers may allow unused amounts to roll over to the next plan year, or they may adopt a “use-it-or-lose-it” approach. The rollover policy must be stated in the formal plan documents and applied consistently to comply with nondiscrimination rules.

Q: Can a Section 105 plan reimburse Medicare premiums?

A: In many cases, yes. If the plan document allows it, Section 105 arrangements can reimburse Medicare Part B, Part D, and Medicare Advantage premiums, provided the employee is properly enrolled in Medicare. This can be especially valuable for employers with older employees who are still active or working past age 65. However, coordination with Medicare Secondary Payer rules should be reviewed carefully.

Q: Does a Section 105 plan require annual IRS filing?

A: Section 105 plans themselves generally do not require a specific annual IRS filing solely because they exist. However, depending on the structure, employers may have related reporting obligations. For example, larger employers subject to the Affordable Care Act may need to complete Forms 1094-C and 1095-C. Additionally, ERISA-covered plans may require Form 5500 filing if they meet certain size thresholds. Employers should confirm their reporting obligations based on company size and plan structure.

Q: Can bonuses or salary reductions fund a Section 105 plan?

A: No. Section 105 plans must be funded solely by the employer. Employees cannot contribute through salary reduction, and the benefit cannot be structured as a cash-or-benefit choice without triggering taxable consequences under constructive receipt rules. If employees are given the option to take cash instead of reimbursement, the arrangement may lose its tax-advantaged status.

Q: What happens if an employee terminates employment mid-year?

A: Reimbursements generally stop upon termination unless the plan includes continuation provisions. Depending on plan structure and employer size, COBRA or state continuation rules may apply. If COBRA applies, the former employee may be able to continue participating in the HRA by paying applicable premiums. Employers must define termination and continuation terms clearly in their plan documents.

Q: Can a Section 105 plan reimburse medical expenses incurred before the plan’s effective date?

A: No. Expenses must be incurred during the period when the employee is covered by the Section 105 plan. Reimbursing pre-plan expenses could jeopardize the tax-free treatment of the benefit. The plan’s effective date should be clearly stated, and reimbursement procedures should verify service dates carefully.

Q: Are part-time or seasonal employees eligible for Section 105 plans?

A: Employers may choose to include or exclude certain classes of employees, such as part-time, seasonal, union, or temporary workers, provided the classifications comply with applicable federal regulations. Eligibility rules must be defined in advance and applied consistently. Arbitrary inclusion or exclusion could create compliance concerns under nondiscrimination standards.

Q: How does Section 105 interact with Workers’ Compensation benefits?

A: Section 105 generally covers medical expenses related to personal health conditions, not workplace injuries covered by Workers’ Compensation insurance. If a medical expense is reimbursed through Workers’ Compensation, it cannot also be reimbursed under a Section 105 plan. Employers should coordinate policies to avoid duplicate payments.

Q: Is there a maximum dollar limit under Section 105?

A: Section 105 itself does not impose a universal dollar cap on reimbursements. However, certain types of HRAs, such as QSEHRA, have annual contribution limits set by the IRS and adjusted for inflation. ICHRA arrangements do not have statutory maximums, but affordability rules under the ACA may indirectly influence reimbursement levels for applicable large employers.

If you’re considering implementing a Section 105-compliant benefit and want clarity tailored to your workforce, our team at SimplyHRA is here to help. Reach out anytime at info@simplyhra.com or schedule a conversation at https://www.simplyhra.com/contact.

Q: Can a Section 105 plan reimburse telehealth services and virtual care?

A: Yes, in most cases. Telehealth visits, virtual mental health counseling, and other remote medical services can qualify for reimbursement under Section 105 if they meet the definition of medical care under IRC Section 213(d). The expense must be medically necessary and properly substantiated. Employers should ensure their plan documents don’t unintentionally exclude telehealth, especially since virtual care has become a standard form of treatment.

Q: Can employers change reimbursement amounts mid-year in a Section 105 plan?

A: Generally, reimbursement amounts are set for the plan year and outlined in formal documents. Mid-year changes can create compliance and fairness concerns, particularly under nondiscrimination rules. However, changes may be permissible if they’re applied prospectively and consistently across an eligible class of employees. Employers should document amendments carefully and provide appropriate notice to participants before implementing changes.

Q: Are gym memberships reimbursable under Section 105?

A: Usually no. Gym memberships and general wellness expenses are not considered qualified medical expenses unless prescribed by a physician to treat a specific medical condition, such as obesity or hypertension. Even then, documentation must clearly show medical necessity. The IRS has historically taken a narrow view of what qualifies, so employers should require detailed substantiation for these types of claims.

Q: Can a Section 105 plan reimburse international medical expenses?

A: Potentially, yes. If the expense qualifies as medical care under Section 213(d), it may be reimbursable even if incurred outside the United States. However, substantiation requirements still apply, and currency conversions should be documented properly. Employers with globally mobile employees should clarify how foreign claims will be reviewed and processed.

Q: How does Section 105 handle employees on unpaid leave?

A: Eligibility during unpaid leave depends on the plan’s terms and applicable federal or state leave laws. For example, employees on FMLA leave may have rights to continue health benefits under the same terms as active employees. Employers should define how reimbursements accrue during unpaid leave and whether participation pauses or continues. Consistency with ERISA and FMLA rules is essential.

Q: Can Section 105 reimburse over-the-counter medications?

A: Yes, but only if current federal rules allow it. Under recent federal changes, over-the-counter medications no longer require a prescription to qualify as medical expenses under Section 213(d). That means items like pain relievers, allergy medications, and menstrual care products may be reimbursable if the plan permits and proper receipts are provided.

Q: What happens if an employer accidentally reimburses an ineligible expense?

A: If an ineligible expense is reimbursed, the amount may need to be treated as taxable wages and reported through payroll corrections. Employers should correct errors promptly and maintain documentation showing how the issue was resolved. Consistent internal review processes can reduce the likelihood of recurring mistakes.

Q: Can a Section 105 plan be offered alongside a Health Savings Account (HSA)?

A: Yes, but with limitations. A traditional Section 105 HRA that reimburses first-dollar medical expenses can make an employee ineligible to contribute to an HSA. However, a limited-purpose HRA that reimburses only dental, vision, or post-deductible expenses may preserve HSA eligibility. Plan design is critical when coordinating these two benefits.

Q: Does Section 105 require employers to pre-fund reimbursement accounts?

A: No. Unlike some benefit accounts, Section 105 plans are typically unfunded arrangements. Employers reimburse expenses as they are incurred and approved. Funds generally remain part of the employer’s general assets until paid. This structure helps with cash flow management, especially for smaller organizations.

Q: Can nonprofit organizations use Section 105 plans?

A: Absolutely. Section 105 applies broadly to employers, including nonprofit entities. Tax-exempt status does not prevent an organization from establishing a compliant reimbursement arrangement. Nonprofits often find Section 105-based HRAs attractive because they allow predictable budgeting while still offering meaningful health benefits.

Q: Are there minimum participation requirements under Section 105?

A: Section 105 itself does not impose minimum participation thresholds like some group insurance carriers do. However, if the arrangement is structured to satisfy Affordable Care Act employer mandate requirements, applicable large employers must ensure the plan meets affordability and minimum value standards where required. Small employers below ACA thresholds generally have more flexibility.

Q: Can employers terminate a Section 105 plan at any time?

A: Employers generally retain the right to amend or terminate a Section 105 plan, provided they follow the amendment procedures outlined in the plan document and give appropriate notice to participants. However, employers must still honor properly incurred and substantiated claims for eligible expenses incurred before the termination date, subject to plan terms.

If you have specific operational or compliance questions about how Section 105 applies to your organization, it’s wise to get guidance tailored to your workforce and entity structure. SimplyHRA can help you navigate those details with clarity and confidence.

Bringing Section 105 to Life for Small Businesses

Section 105 isn’t just a line in the tax code — it’s the legal engine that makes tax-free health reimbursements possible. When structured properly, it gives small businesses cost control, gives employees meaningful choice, and keeps everyone aligned with IRS and Department of Labor rules. But as we’ve covered, compliance, documentation, substantiation, nondiscrimination testing, and payroll coordination all matter. Done right, it’s powerful. Done casually, it can create tax exposure and administrative headaches.

At SimplyHRA, we’ve worked with founders, HR managers, and growing teams who were tired of unpredictable group plan renewals and overwhelmed by compliance complexity. We’ve been in those conversations where a 20% premium increase felt like a punch in the gut. By helping businesses implement Section 105-compliant HRAs like ICHRA, we’ve seen companies regain budget predictability, reduce administrative strain, and give employees the freedom to choose coverage that actually fits their lives. Our platform automates the heavy lifting — from plan documents to substantiation to payroll integration — so employers can focus on running their business, not decoding federal regulations.

If your company is navigating rising health costs, compliance concerns, or simply wants a smarter way to offer benefits under Section 105, let’s talk. Email us at info@simplyhra.com or schedule a consultation at https://www.simplyhra.com/contact. We’d be honored to help you design a health benefits program your team will value — without the cost and complexity of traditional group insurance.