How to Set Up a Section 105 Medical Reimbursement Plan

A Section 105 Medical Reimbursement Plan is a health benefit established by an employer that is governed by the Internal Revenue Code (IRC). Its function is to provide tax-free reimbursements to employees for medical care expenses they have incurred. The plan is entirely funded by the employer, as employees cannot contribute through salary deductions. As a formal, written arrangement, it operates as a self-funded health benefit where the business reimburses employees directly for qualified health expenses. This structure allows employers to maintain control over costs and offer health benefits outside of traditional group insurance policies.

Determining Eligibility and Plan Type

A business’s legal structure is the primary factor in determining if an owner can participate in a Section 105 plan. For C-Corporations, the entity is legally separate from its owners, allowing owner-employees who receive a salary to participate and receive tax-free reimbursements. The rules differ for other business types, as S-Corporation owners who hold more than 2% of the company’s shares are not eligible for tax-free benefits. Similarly, owners of sole proprietorships and partnerships cannot receive these benefits because they are not considered W-2 employees.

A strategy for sole proprietorships and partnerships is to hire the owner’s spouse as a bona fide W-2 employee. The plan can then be established to cover the employee-spouse. This allows the spouse to claim qualifying medical expenses for their family, which includes the business owner.

Once eligibility is confirmed, the employer selects a plan type, which is a form of Health Reimbursement Arrangement (HRA). A Qualified Small Employer Health Reimbursement Arrangement (QSEHRA) is an option for employers with fewer than 50 full-time equivalent employees who do not offer a group health plan. QSEHRAs have annual reimbursement limits, which for 2025 are $6,350 for self-only coverage and $12,800 for family coverage.

An Individual Coverage Health Reimbursement Arrangement (ICHRA) is another option available to employers of any size. This plan provides tax-free reimbursements for premiums that employees pay for individual health insurance policies. Unlike a QSEHRA, an ICHRA has no contribution limits, and employers can offer different allowance amounts to different classes of employees, such as full-time versus part-time staff.

Required Documentation and Information

The foundation of a compliant Section 105 plan is the formal plan document, which is required by the IRS and must be in writing. It serves as the official rulebook for the plan and must be created before any reimbursements can be made. The document must contain specific information to be compliant.

The plan document must detail several key components, including:

• The name of the plan administrator and other fiduciaries.
• Eligibility requirements for employees, based on factors like job classification or a waiting period.
• The exact reimbursement amounts or annual limits the employer will provide.
• The plan’s effective start date and plan year.
• A list of medical expenses eligible for reimbursement, often by referencing Internal Revenue Code Section 213.
• The procedures employees must follow to submit a claim for reimbursement.

Alongside the plan document, the business must prepare a Summary Plan Description (SPD). The SPD is an employee-facing document that explains the plan’s benefits and rules in understandable language. To complete these documents, the business owner must gather the full legal name of the business, its physical address, its Employer Identification Number (EIN), and a clear definition of any employee classes.

The Establishment and Implementation Process

Once the plan documents are complete, the business must formally adopt the plan to bring it into legal existence. For a corporation, this process is finalized through a board of directors’ resolution recorded in the meeting minutes. For other entities like sole proprietorships or partnerships, the formal adoption occurs when the owner signs and dates the official plan document.

Following adoption, the employer must inform employees by distributing the Summary Plan Description to every eligible employee. The Employee Retirement Income Security Act (ERISA) sets deadlines for this distribution. For a new plan, the SPD must be provided to participants within 120 days of its establishment, while new employees must receive it within 90 days of becoming covered.

The business must also establish systems for day-to-day operation. This involves creating a clear and secure process for employees to submit claims for reimbursement, such as a dedicated form or an online portal. The employer must also set up a reliable mechanism for making the tax-free reimbursement payments, either as a non-taxable item on a paycheck or through a separate payment.

Ongoing Plan Administration

After a Section 105 plan is established, the employer has ongoing responsibilities to ensure compliance. A primary duty is recordkeeping, which requires maintaining copies of the official plan document, the Summary Plan Description (SPD), and any amendments. The business must also keep all employee reimbursement claims, corresponding proof of expense, and a record of every payment made.

A core administrative function is the review of employee claims. The plan administrator must verify that each expense is eligible as defined in the plan document and that the employee has provided adequate substantiation, such as a receipt. This review ensures that all reimbursements are legitimate and comply with IRS rules.

Plans must adhere to nondiscrimination rules under IRC Section 105 to ensure they do not unfairly favor highly compensated individuals (HCIs). Self-insured plans are subject to testing that examines both eligibility and benefits. The eligibility test assesses whether enough non-HCIs are benefiting, while the benefits test ensures that all benefits available to HCIs are also available to all other participants.

If the employer changes the plan, such as altering reimbursement limits, a formal amendment to the plan document is required. Following the amendment, the employer must notify employees of the change. This is done by distributing either a completely updated SPD or a Summary of Material Modifications (SMM) that details the specific changes.