Healthcare Reimbursement Plan for Business Owners: Try a Section 105 Plan

Understanding a Section 105 Plan

A Section 105 plan is an employer-sponsored medical reimbursement arrangement. It allows tax-free reimbursement of employee healthcare expenses. This includes medical, dental, and vision costs.

Unlike traditional insurance, a Section 105 plan reimburses employees for actual expenses rather than paying premiums. It provides flexibility for employers. Plan terms can be customized.

The plan is funded solely by the employer. Employees cannot contribute to the plan. This keeps the tax benefits intact.

A written plan document is required. It must outline eligible expenses, reimbursement limits, and claim procedures. This ensures compliance with IRS rules.

How a Section 105 Plan Works

The employer establishes the plan and sets an annual reimbursement limit. This controls costs while offering valuable benefits to employees.

Employees submit claims with receipts or equivalent documentation. The employer reviews and approves valid expenses. Reimbursements are then issued tax-free.

Eligible expenses follow IRS Publication 502 guidelines. These may include doctor visits, prescription drugs, and medical procedures. Cosmetic expenses are not eligible.

The plan can cover employees and their dependents. Spouses, children, and other qualified dependents may receive reimbursements for eligible healthcare expenses.

Tax Benefits for Business Owners

Section 105 plans provide significant tax advantages. Reimbursements are a deductible business expense for the employer. This reduces taxable income.

For employees, reimbursements are not subject to federal income tax. They are also exempt from state income tax in most states.

If structured correctly, sole proprietors employing their spouse can also reduce self-employment tax. This applies to Social Security and Medicare contributions.

C-corporations benefit the most. Owners can fully participate in the plan as employees. This makes the benefit extremely tax-efficient for owner-operators.

Section 105 Plans for Sole Proprietors and S-Corp Owners

Sole proprietors cannot directly participate in a Section 105 plan. However, they can employ their spouse and extend coverage to themselves.

The spouse must be a bona fide employee. This includes performing legitimate work for the business. The arrangement must meet payroll and employment standards.

S-Corp owners with more than 2% ownership are treated differently. Their reimbursements are taxable for income tax purposes but remain exempt from payroll taxes.

Both structures require careful documentation. A written plan document, payroll records, and substantiated claims are essential to maintain compliance and tax benefits.

Compliance Requirements and Documentation

The IRS requires a written plan document for all Section 105 plans. This must detail eligibility, benefits, and administrative procedures.

Reimbursements must be substantiated. Employees must submit receipts, invoices, or equivalent proof. Self-certification is not allowed.

Employers must retain plan documents and claim records for at least three years. This protects against potential IRS audits.

HIPAA privacy rules may apply. Employers must safeguard employee medical information. Many businesses use third-party administrators to handle sensitive data securely.

Benefits Beyond Taxes

A Section 105 plan increases employee satisfaction. Employees value reimbursement for real healthcare costs over generic insurance coverage.

The plan can be tailored to workforce needs. Employers can include dental and vision care, wellness programs, and preventive services.

Unused funds remain with the employer. Unlike insurance premiums, unused reimbursement allowances do not disappear at year-end unless the plan allows rollovers.

Plans are flexible. Employers can adjust limits annually based on budget and company performance without renegotiating insurance contracts.

Category	Details	Typical Options / Notes
Plan Type	Employer-funded, tax-advantaged reimbursement arrangement for medical expenses.	Section 105 HRA; not salary-reduction.
Eligibility	Defined by employer’s plan document (e.g., full-time employees).	Classes may vary; owners may have special rules.
Funding	Employer-only dollars; no employee contributions.	Notional accounts; pay-as-you-go reimbursements.
Allowance	Annual reimbursement limit set by employer.	May be prorated for mid-year hires.
Covered Expenses	Section 213(d) medical expenses (as defined in the plan).	Copays, deductibles, Rx, dental, vision, etc., if allowed.
Premium Reimbursement	May reimburse individual or group premiums if plan allows.	Check ACA-compatible designs (e.g., ICHRA/QSEHRA).
Substantiation	Claims require receipts/Explanation of Benefits (EOB).	Third-party review recommended; store securely.
Reimbursement Method	Post-tax employee pays, employer reimburses tax-free.	Payroll or AP; timely processing policies help.
Tax Treatment	Employer: deductible; Employee: generally tax-free.	Subject to plan and eligibility rules.
Carryover	Unused amounts may carry over if plan allows.	Define cap and forfeiture in plan document.
Run-Out Period	Time window after plan year to submit claims.	Commonly 60–90 days; specify in SPD.
Coordination with HSA	Limited-purpose/post-deductible HRAs preserve HSA eligibility.	Dental/vision only until deductible met, if desired.
Nondiscrimination	Benefits cannot favor highly compensated individuals.	Test annually; document methodology.
Plan Documents	Formal plan document and Summary Plan Description (SPD) required.	Update for design or legal changes.
ERISA Compliance	Most HRAs are ERISA plans with notice and disclosure duties.	Wrap plan/SPD can simplify compliance.
HIPAA / Privacy	Protect PHI; limit employer access to medical details.	Use HIPAA-compliant administrators and processes.
ACA Considerations	Design must align with ACA market rules.	Consider ICHRA/QSEHRA structures for premiums.
COBRA	COBRA may apply to HRAs for eligible employers.	Define premium and value method in plan.
Termination / Forfeiture	Unused balances typically forfeit at termination unless plan says otherwise.	Spell out rules in SPD; consider grace policies.
Administration	Maintain records, approve claims, provide required notices.	TPA or in-house with strict procedures.

Is a Section 105 Plan Right for Your Business?

Small businesses with limited budgets can benefit greatly. Section 105 plans deliver high value without excessive premium costs.

Businesses with healthy workforces often save more. They reimburse fewer expenses than they would pay in insurance premiums.

If attracting and retaining talent is a priority, a Section 105 plan adds competitive advantage. It signals commitment to employee well-being.

Business owners should consult a tax professional or benefits advisor before implementation. Proper setup ensures compliance and maximizes tax savings.