Section 105 Plan

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Introduction to the Section 105 Plan

If you’re a small business owner or HR manager trying to make sense of health benefits, the term Section 105 Plan may sound technical—maybe even intimidating. Don’t worry. At its core, a Section 105 Plan is simply a tax-advantaged way for employers to reimburse employees for eligible medical expenses.

Created under Section 105 of the Internal Revenue Code, this type of arrangement allows employers to reimburse employees for medical care expenses tax-free. That means reimbursements are generally deductible to the business and excluded from employees’ gross income, provided the plan is structured properly under IRS rules.

For small employers balancing budgets and compliance, that’s a big deal.

Let’s break it down in plain English—what it is, how it works, and what small businesses need to watch out for.

What Is a Section 105 Plan?

A Section 105 Plan is an employer-funded health reimbursement arrangement. It allows businesses to reimburse employees for qualified medical expenses as defined under Internal Revenue Code Section 213(d).

According to the IRS (see IRS Publication 502 and IRS Publication 969), eligible expenses may include:

• Health insurance premiums
• Doctor visits and hospital services
• Prescription medications
• Mental health treatment
• Certain dental and vision expenses

How It Differs from Group Insurance

Unlike traditional group health insurance:

• The employer doesn’t purchase a one-size-fits-all policy.
• The employer sets reimbursement rules.
• Employees can be reimbursed for their own qualifying coverage and expenses.

In many cases today, modern Health Reimbursement Arrangements (HRAs), including ICHRA and QSEHRA, are structured forms of Section 105 Plans that comply with Affordable Care Act (ACA) requirements.

How a Section 105 Plan Works in Practice

Let’s walk through a simple example.

Imagine you run a 12-person marketing agency. Instead of offering a $800-per-month group health plan per employee, you decide to offer a reimbursement allowance of $400 per month through a properly structured Section 105 Plan.

Here’s how it works:

1. You define eligibility rules and reimbursement limits.
2. Employees purchase individual health insurance that meets Minimum Essential Coverage (MEC) requirements.
3. Employees submit proof of eligible expenses.
4. The business reimburses those expenses tax-free.

From a tax perspective:

• The business deducts reimbursements as a business expense.
• Employees don’t pay federal income tax or payroll tax on those reimbursements.

That tax treatment is the real engine behind Section 105.

Compliance Rules Small Businesses Must Understand

Now, here’s where things get serious.

A Section 105 Plan must comply with multiple federal laws, not just the tax code.

IRS Requirements

The IRS requires:

• A formal written plan document
• Clear eligibility rules
• Defined reimbursement limits
• Substantiation of medical expenses

You can’t just “informally” reimburse employees for medical costs and call it a day. Without a formal plan, reimbursements could become taxable wages.

Affordable Care Act (ACA) Rules

After the ACA was enacted, stand-alone Section 105 Plans that reimbursed individual premiums without meeting ACA market reforms became non-compliant.

The Department of Labor and IRS issued guidance (see IRS Notice 2013-54 and DOL Technical Release 2013-03) clarifying that:

• Standalone HRAs must satisfy ACA requirements.
• Employers cannot simply reimburse individual premiums without using an ACA-compliant structure like ICHRA or QSEHRA.

Failure to comply can trigger penalties under Internal Revenue Code Section 4980D—up to $100 per employee per day.

That’s not pocket change.

Types of Section 105 Plans Available Today

The phrase Section 105 Plan is broad. Several modern benefit designs fall under its umbrella.

QSEHRA (Qualified Small Employer HRA)

Available to employers with fewer than 50 full-time equivalent employees.

Key features:

• Annual reimbursement limits set by the IRS
• Employees must have Minimum Essential Coverage
• Employers cannot offer a group health plan simultaneously

ICHRA (Individual Coverage HRA)

Available to employers of any size.

Key features:

• No annual contribution limits
• Employee classes allowed (full-time, part-time, seasonal, etc.)
• Works alongside ACA affordability standards

ICHRA has become one of the most flexible modern versions of a Section 105 Plan.

Integrated HRA

Designed to supplement a traditional group health plan by reimbursing out-of-pocket costs.

Advantages for Small Business Owners

For business owners, flexibility and cost predictability matter.

A Section 105 Plan offers:

• Cost control: You set the reimbursement amount.
• Tax efficiency: Reimbursements are deductible.
• Budget stability: No surprise premium renewals.
• Customization: Different employee classes can receive different allowances (with ICHRA).

Instead of being locked into annual premium increases dictated by an insurance carrier, you control the benefit budget.

That’s empowering.

Benefits for Employees

From the employee’s perspective, the value is freedom.

Employees can:

• Choose their own insurance plan on Healthcare.gov or through a licensed broker.
• Select coverage that fits their doctors and prescriptions.
• Keep their plan even if they change jobs (in most cases).

According to Healthcare.gov, individual coverage must meet Minimum Essential Coverage standards to qualify for tax-free reimbursement. That ensures employees maintain comprehensive protection.

It’s not just about cost—it’s about personalization.

Common Mistakes to Avoid

Even well-intentioned employers can stumble.

Here are common pitfalls:

1. Informal reimbursements
   Simply paying premiums through payroll without a compliant plan can trigger tax and ACA penalties.

2. Failing nondiscrimination rules
   Section 105 Plans cannot favor highly compensated employees unless structured carefully.

3. Ignoring documentation requirements
   The IRS requires substantiation of expenses before reimbursement.

4. Overlooking affordability rules (for larger employers)
   Applicable Large Employers (50+ FTEs) must ensure affordability under ACA employer mandate rules (see IRS Code Section 4980H).

Compliance isn’t optional—it’s foundational.

Is a Section 105 Plan Right for Your Business?

It depends on your goals.

Ask yourself:

• Do I want predictable health benefit costs?
• Do my employees value flexibility?
• Am I prepared to administer compliance requirements properly?
• Do I lack the HR infrastructure for a complex group plan?

For startups, distributed teams, and small employers priced out of traditional group coverage, this approach often makes financial and operational sense.

That said, administration matters. Handling substantiation, privacy protections (HIPAA), and regulatory updates manually can quickly become overwhelming.

Which brings us to technology.

Why Administration Makes or Breaks a Section 105 Plan

A compliant plan requires:

• Plan documents
• Employee notices
• Expense verification
• Secure data handling
• Reimbursement tracking
• Payroll coordination
• Audit-ready reporting

Trying to manage that through spreadsheets? That’s risky.

The Department of Labor and IRS expect documentation. If you’re ever audited, “we didn’t know” won’t cut it.

Technology platforms built specifically for HRAs eliminate those administrative landmines while keeping your plan compliant and efficient.

Final Thoughts on Section 105 Plan Strategy

A Section 105 Plan can be one of the most tax-efficient, flexible health benefit strategies available to small businesses—but only when structured correctly under IRS and ACA rules. That’s exactly where SimplyHRA comes in. We help small business owners and HR managers design compliant ICHRA and QSEHRA solutions, automate reimbursements, handle documentation, and provide 24/7 support so employees feel confident in their coverage choices. If you’re considering implementing or modernizing your health benefits strategy, reach out to us at info@simplyhra.com or schedule a consultation at https://www.simplyhra.com/contact. Let’s build a health benefits experience your employees will actually love.

Section 105 Plan and Business Owner Eligibility

One area that often causes confusion with a Section 105 Plan is whether business owners themselves can participate. The answer? It depends entirely on how your business is structured and taxed.

C-Corporation Owners

If your business is taxed as a C-corporation, you’re generally considered an employee of the corporation. That means:

• The corporation can reimburse your medical expenses.
• Reimbursements are typically tax-free to you.
• The business deducts the expense.

For C-corp owners, a Section 105 Plan can be especially powerful because it allows full participation alongside other employees.

S-Corporation Owners (2% Shareholders)

This is where things get tricky.

If you own more than 2% of an S-corporation, IRS rules treat you differently. You’re not considered a common-law employee for certain fringe benefit purposes. In practical terms:

• Your health insurance premiums may need to be included in your W-2 wages.
• You may still deduct premiums on your personal tax return under self-employed health insurance rules (see IRS Publication 535).
• Reimbursements are not automatically tax-free the same way they are for rank-and-file employees.

It’s legal to structure correctly—but it must be handled carefully with payroll and tax reporting.

Partnerships and Sole Proprietors

Partners and sole proprietors are not employees of their businesses. That means they typically cannot participate in a Section 105 Plan in the same way W-2 employees can.

Instead:

• Premiums may be deductible on their personal return.
• Reimbursement must be structured carefully to avoid compliance issues.

This is one of those areas where coordination between your CPA, payroll provider, and HRA administrator really matters.

Nondiscrimination Rules Under Section 105

Section 105 Plans are subject to nondiscrimination requirements under Internal Revenue Code Section 105(h).

In plain terms, you can’t design a plan that disproportionately benefits highly compensated employees.

What Counts as Discrimination?

A plan may fail nondiscrimination testing if:

• Only executives are eligible.
• Highly compensated employees receive larger benefits without a compliant class structure.
• Eligibility rules indirectly exclude lower-paid staff.

If a plan fails nondiscrimination testing:

• Reimbursements to highly compensated employees may become taxable.
• Rank-and-file employees remain tax-free.

For small businesses, especially family-run companies, this rule is easy to overlook. But it’s not optional.

Modern ICHRA designs allow different reimbursement amounts by employee class—full-time versus part-time, salaried versus hourly—but the classes must follow IRS and Department of Labor guidelines.

Section 105 Plan and Payroll Coordination

Let’s talk logistics.

Even though reimbursements are tax-free, they still interact with payroll systems.

Reimbursement Timing

Employers must decide:

• Will reimbursements occur monthly?
• Will unused allowances roll over?
• Will payments be added to payroll or issued separately?

Improper payroll handling can accidentally trigger:

• FICA taxes
• FUTA taxes
• State payroll tax complications

Pre-Tax vs. Post-Tax Confusion

Some employers confuse Section 105 Plans with Section 125 cafeteria plans.

Here’s the difference:

• Section 105 = Employer-funded reimbursements.
• Section 125 = Employee salary deferrals on a pre-tax basis.

They can work together—but they’re not the same thing. Mixing them up can cause reporting errors.

How Section 105 Plans Affect Employees’ Marketplace Subsidies

Employees who purchase insurance on Healthcare.gov may qualify for premium tax credits under the Affordable Care Act.

However, participation in a Section 105 Plan—particularly an ICHRA—can affect subsidy eligibility.

Affordability Matters

If the employer’s reimbursement makes coverage “affordable” under ACA standards:

• The employee becomes ineligible for premium tax credits for that month.

If it’s deemed unaffordable:

• The employee may decline the HRA and seek Marketplace subsidies instead.

Affordability calculations compare:

• The employee’s required contribution for the lowest-cost Silver plan (self-only)
• Minus the employer’s reimbursement
• Against the IRS affordability percentage threshold (updated annually by the IRS).

This calculation isn’t something most employees can do on their own—which is why education and support are critical.

Recordkeeping and Audit Readiness

The IRS and Department of Labor both expect documentation.

A compliant Section 105 Plan must maintain:

• Formal plan documents
• Summary plan descriptions (SPD)
• Employee notices (for ICHRA/QSEHRA)
• Proof of Minimum Essential Coverage
• Substantiated expense records
• Reimbursement logs

HIPAA Privacy Considerations

Because employees submit medical expense documentation, employers must protect sensitive health information.

Without proper safeguards:

• You risk HIPAA violations.
• You create internal privacy concerns.
• You expose the business to legal liability.

That’s why most small businesses shouldn’t directly handle employee medical receipts themselves. A third-party administrator or compliant software platform creates a firewall between employer and medical details.

Section 105 Plan for Remote and Multi-State Teams

Today’s workforce isn’t confined to one ZIP code.

For remote-first companies, traditional group insurance can be limiting:

• Some carriers restrict provider networks by state.
• Multi-state group plans often cost more.
• Employees may struggle to find in-network doctors.

A Section 105 Plan structured as an ICHRA solves this by allowing:

• Employees in different states to choose local coverage.
• The employer to maintain one consistent reimbursement strategy.
• Scalability as the company grows.

For startups hiring nationally, this flexibility is often the tipping point.

Long-Term Cost Forecasting with a Section 105 Plan

One underrated advantage is financial predictability.

Traditional group health insurance often comes with:

• Annual renewal negotiations
• Double-digit premium increases
• Limited plan design flexibility

With a defined reimbursement model:

• You set the budget.
• Increases are employer-controlled.
• There’s no carrier-imposed renewal shock.

Over a five-year horizon, that stability can dramatically improve financial planning—especially for venture-backed startups and cash-conscious small businesses.

Section 105 Plan Strategy Done Right

A Section 105 Plan isn’t just a reimbursement tool—it’s a framework governed by tax law, ACA regulations, nondiscrimination rules, and documentation requirements. When structured properly, it delivers cost control for employers, choice for employees, and meaningful tax advantages for both. But when handled casually, it can create compliance exposure.

At SimplyHRA, we help small businesses design compliant ICHRA and QSEHRA solutions rooted in Section 105 rules, automate documentation and reimbursements, integrate with payroll, and provide employees with real-time support so no one feels lost in the process. If you’re evaluating your health benefits strategy or want to ensure your current approach is compliant, email us at info@simplyhra.com or schedule a consultation at https://www.simplyhra.com/contact. Let’s make health benefits simpler—and smarter—for your business.

Frequently Asked Questions (FAQs) about Section 105 Plan:

Q: Can a Section 105 Plan reimburse family members of employees?

A: Yes, in many cases a Section 105 Plan can reimburse eligible medical expenses for an employee’s spouse and tax dependents, as defined under Internal Revenue Code Section 152. That may include premiums, copays, prescriptions, and other qualified medical expenses under Section 213(d). However, reimbursements must follow the written plan document, and eligibility definitions must be applied consistently across employees to satisfy nondiscrimination rules.

Q: Are there contribution limits under a Section 105 Plan?

A: It depends on the type of arrangement. Traditional integrated HRAs and ICHRAs generally do not have statutory annual contribution limits. However, QSEHRAs do have annual maximum reimbursement limits set by the IRS and adjusted each year for inflation. Employers should always confirm current limits directly from IRS guidance before finalizing plan design.

Q: Can a Section 105 Plan reimburse Medicare premiums?

A: Yes, if structured properly, a Section 105 Plan can reimburse Medicare Part B, Part D, and Medicare Advantage premiums for eligible employees. Employers must ensure the arrangement complies with Medicare Secondary Payer rules, especially if the employer has 20 or more employees. Coordination rules are enforced by the Centers for Medicare & Medicaid Services (CMS), so compliance matters.

Q: What happens to unused funds at the end of the year?

A: Unlike an HSA, a Section 105 Plan is employer-funded and employer-owned. Whether unused allowances roll over depends entirely on the plan design. Employers may allow rollover of unused amounts, cap the rollover, or reset balances annually. Importantly, employees do not “take” unused funds with them if they leave the company unless the plan specifically allows post-termination reimbursements.

Q: Can employees contribute their own money to a Section 105 Plan?

A: No. A Section 105 Plan must be fully employer-funded. Employees cannot salary-reduce into the plan unless it is paired with a separate Section 125 cafeteria plan structure for premium sharing. Even then, the Section 105 portion remains employer-funded only. Mixing employee contributions directly into a Section 105 Plan would jeopardize its tax-advantaged status.

Q: Is a Section 105 Plan subject to ERISA?

A: In most cases, yes. A Section 105 Plan is considered a group health plan under the Employee Retirement Income Security Act (ERISA). That means employers must provide a Summary Plan Description (SPD) and comply with federal reporting and fiduciary standards. Small employers are often surprised by this requirement, but ERISA applies regardless of company size in most circumstances.

Q: Do COBRA rules apply to a Section 105 Plan?

A: Sometimes. If the employer is subject to federal COBRA (generally 20 or more employees), a Section 105 Plan that qualifies as a group health plan may require continuation coverage. However, the application of COBRA depends on the structure of the arrangement and whether there is an underspent account balance. State mini-COBRA laws may also apply for smaller employers. Employers should evaluate this carefully during plan setup.

Q: Can a Section 105 Plan reimburse wellness expenses like gym memberships?

A: Generally, no. The IRS limits tax-free reimbursement to qualified medical expenses under Section 213(d). Gym memberships are typically not eligible unless prescribed by a physician to treat a specific medical condition, and even then, substantiation requirements are strict. Employers should avoid broad “wellness” reimbursements unless they clearly meet IRS definitions.

Q: How quickly can a small business implement a Section 105 Plan?

A: Implementation timelines vary depending on complexity, employee classes, and compliance documentation. A properly structured plan requires drafting legal documents, setting reimbursement policies, preparing employee notices, and coordinating payroll. With modern HRA administration platforms, setup can often be completed within weeks rather than months, provided employer decisions are made promptly.

Q: What happens if an employee loses individual health coverage mid-year?

A: If the plan requires Minimum Essential Coverage as a condition of reimbursement, reimbursements must stop for months when the employee does not have qualifying coverage. Employers are responsible for verifying ongoing coverage eligibility. Continuing to reimburse without proof of coverage could jeopardize the tax-free treatment of the plan.

Q: Can a Section 105 Plan be combined with a Health Savings Account (HSA)?

A: It can, but only if structured carefully. A general-purpose Section 105 Plan that reimburses first-dollar medical expenses will typically make an employee ineligible to contribute to an HSA. However, a limited-purpose HRA that reimburses only dental and vision expenses can preserve HSA eligibility. Employers should clearly define reimbursement categories if HSA compatibility is a priority.

Q: Does offering a Section 105 Plan satisfy the employer mandate for large employers?

A: It can, if structured as an affordable ICHRA that meets ACA affordability and minimum value standards under Internal Revenue Code Section 4980H. Applicable Large Employers (50 or more full-time equivalent employees) must carefully calculate affordability using IRS safe harbors. Simply offering reimbursements without meeting these standards would not satisfy the mandate.

If you’re considering whether a Section 105 Plan fits your business model, compliance obligations, or growth plans, it’s wise to review your structure carefully before implementation. Done correctly, it can be a flexible and tax-efficient health benefit strategy.

Q: Can a Section 105 Plan cover part-time or seasonal employees?

A: Yes, but eligibility rules must be clearly defined in the written plan document and applied consistently. Employers may choose to include or exclude part-time and seasonal workers, depending on business goals. However, eligibility classifications must comply with nondiscrimination rules and, if using an ICHRA structure, must align with permitted employee classes defined by federal regulations.

Q: Are reimbursements under a Section 105 Plan subject to state taxes?

A: In most states, properly structured reimbursements are excluded from state income tax just like federal income tax. However, state tax treatment can vary. Employers should confirm state-specific guidance, particularly in states with unique payroll or disability insurance rules, to ensure proper withholding and reporting.

Q: Does a Section 105 Plan require annual reporting to the IRS?

A: Standalone Section 105 arrangements themselves generally do not require a specific annual IRS filing solely because they exist. However, employers may have related reporting obligations. For example, Applicable Large Employers must complete Forms 1094-C and 1095-C under ACA reporting rules. In addition, ERISA plans may require Form 5500 filing if the plan reaches certain size thresholds (typically 100 or more participants).

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

A: Yes, over-the-counter medications are eligible for reimbursement if they meet the definition of qualified medical expenses under IRS Section 213(d). Following changes made by the CARES Act in 2020, over-the-counter drugs no longer require a prescription to be reimbursable. Proper substantiation, such as itemized receipts, is still required.

Q: What documentation must employees provide for reimbursement?

A: Employees must provide proof that includes the date of service, description of the expense, amount paid, and the provider’s name. Credit card receipts alone are usually insufficient because they don’t show the medical nature of the expense. Employers must review and retain documentation in accordance with IRS and ERISA recordkeeping requirements.

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

A: No, expenses must generally be incurred after the plan’s official effective date to qualify for tax-free reimbursement. Retroactive reimbursements for expenses incurred before the plan existed could jeopardize compliance and tax treatment. Employers should ensure the plan document clearly states the effective date.

Q: Is there a minimum employer contribution required?

A: There is no universal federal minimum contribution requirement for a Section 105 Plan. Employers have discretion to set reimbursement amounts, subject to affordability rules if they are an Applicable Large Employer. That flexibility allows small businesses to design benefits around their budget rather than insurance carrier mandates.

Q: What happens if an employee submits a fraudulent claim?

A: Employers are responsible for ensuring claims are substantiated. If fraud is suspected, the claim should be denied and documented appropriately. Reimbursing unverified or fraudulent expenses can create tax exposure and compliance risk. A clear claims review process and secure administration system reduces this risk significantly.

Q: Can a Section 105 Plan be amended mid-year?

A: Yes, employers may amend the plan, but changes must be documented formally and communicated to employees in advance. Certain changes, such as reducing benefits, may raise employee relations concerns or trigger notice requirements. Consistency and proper documentation are critical when making mid-year adjustments.

Q: Are former employees eligible to continue submitting expenses?

A: Eligibility after termination depends on the plan design and whether COBRA applies. Some plans allow reimbursement for expenses incurred before termination but submitted afterward within a defined runout period. Ongoing post-termination participation is generally limited unless required under COBRA or state continuation laws.

Q: Does offering a Section 105 Plan affect workers’ compensation coverage?

A: No, a Section 105 Plan does not replace or alter workers’ compensation obligations. Workers’ compensation covers job-related injuries and illnesses under state law, while a Section 105 Plan reimburses general medical expenses. The two systems operate independently.

Q: Can nonprofit organizations offer a Section 105 Plan?

A: Yes, nonprofit organizations can establish and maintain a Section 105 Plan for their employees. The same IRS and ERISA compliance standards apply regardless of whether the employer is for-profit or nonprofit. Tax-exempt status does not eliminate the need for proper documentation and plan administration.

Q: How long must employers retain Section 105 Plan records?

A: While the IRS does not specify an exact retention period exclusively for Section 105 Plans, employers commonly retain records for at least seven years to align with general federal tax recordkeeping practices. ERISA-related documents should also be maintained in accordance with Department of Labor guidance to ensure audit readiness.

Q: Can reimbursement amounts vary by family size?

A: Yes, reimbursement structures can vary based on family status, such as self-only versus family coverage, if defined in the plan document and applied consistently. When structured as an ICHRA, employers may scale allowances based on age and family size within regulatory limits. Clear documentation and consistent application are essential to remain compliant.

A Smarter Way to Manage Your Section 105 Plan

A Section 105 Plan can be one of the most flexible and tax-efficient tools available to small businesses—but only if it’s designed and administered correctly. Between IRS documentation requirements, nondiscrimination testing, ACA affordability rules, payroll coordination, ERISA obligations, and employee education, there’s a lot that can go sideways if you’re piecing it together on your own. I’ve worked with founders and HR managers who started with good intentions, only to realize the compliance burden and administrative workload were heavier than expected.

That’s exactly why we built SimplyHRA. We’ve been in your shoes—balancing budgets, answering employee questions at odd hours, and trying to stay compliant without hiring a full in-house benefits team. Our platform helps small businesses create and manage compliant Section 105-based HRAs like ICHRA and QSEHRA, automate reimbursements, integrate with payroll, protect employee privacy, and generate audit-ready documentation. Employees get the freedom to choose coverage that fits their lives, while employers keep full control over costs. No surprises. No unnecessary complexity.

If you’re offering a Section 105 Plan—or thinking about it—and want to make sure it’s compliant, efficient, and actually working for your team, 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 health benefits your employees will truly value.