Notice 2016-16: QSEHRA Rules for Small Employers

IRS Notice 2016-16 provides guidance on Qualified Small Employer Health Reimbursement Arrangements (QSEHRAs), which were established by the 21st Century Cures Act. A QSEHRA allows small employers to reimburse employees for health insurance premiums and other qualifying medical expenses without establishing a traditional group health plan. This notice clarifies the operational rules, eligibility requirements, and compliance obligations for employers choosing to offer this benefit.

Employer and Employee Eligibility

To offer a QSEHRA, an organization must qualify as an “eligible employer.” This designation is for employers that are not considered Applicable Large Employers (ALEs) under the Affordable Care Act, meaning they have fewer than 50 full-time equivalent employees. A requirement for eligibility is that the employer cannot offer a group health plan, such as traditional insurance coverage or a flexible spending account (FSA), to any of its employees.

Once an employer is eligible, the QSEHRA must be offered to all of its employees. However, the rules permit the exclusion of certain employee categories. An employer can legally exclude the following from participation:

• Employees who have not completed 90 days of service
• Employees who have not reached age 25
• Part-time workers
• Seasonal workers

QSEHRA Funding and Reimbursement Rules

A QSEHRA must be funded exclusively by the employer; employees cannot contribute through salary reduction or other means. The Internal Revenue Service sets annual limits on the total reimbursement amount, which are adjusted periodically for inflation and differ based on coverage. For 2025, the total reimbursement cannot exceed $6,350 for self-only coverage or $12,800 for family coverage.

The arrangement must be provided on the “same terms” to all eligible employees. While the base offer is uniform, the actual reimbursement amounts can vary based on factors like an employee’s age or the number of family members covered by their health insurance. Unused funds at the end of a plan year remain with the employer, who can choose to roll them over for future use.

To receive reimbursements tax-free, an employee must provide proof of having Minimum Essential Coverage (MEC), which is a standard of health insurance under the Affordable Care Act. With MEC, reimbursements for qualified medical expenses are not included in gross income. Eligible expenses are defined under Internal Revenue Code Section 213 and include insurance premiums, deductibles, copayments, and other medical costs.

Written Notice Requirements for Employers

Employers are obligated to provide a written notice to all eligible employees that outlines the QSEHRA. This notice must be furnished at least 90 days before the beginning of each year the plan is offered. For an employee who becomes eligible during the year, the notice must be provided on or before their eligibility date.

The notice must state the total permitted benefit amount the employee is eligible to receive for the year. It must also include a statement advising the employee to inform any Health Insurance Marketplace of their QSEHRA benefit amount when applying for advance premium tax credits, as this can affect their eligibility.

The notice must also state that an employee must maintain Minimum Essential Coverage (MEC) for reimbursements to be excluded from their taxable income. It should warn that individuals who fail to maintain MEC may be subject to penalties. Failure to provide this comprehensive notice on time can result in penalties for the employer.

Tax and Reporting Obligations

The tax treatment of a QSEHRA is favorable when rules are followed. For the employer, reimbursements are a tax-deductible business expense. For the employee, payments received are not taxable income, provided the employee maintains Minimum Essential Coverage. If an employee does not have MEC, any reimbursements become fully taxable.

Employers have a specific reporting duty for the QSEHRA. The amount of the permitted benefit must be reported on each employee’s annual Form W-2 in Box 12, using code “FF.” This reporting is for informational purposes and does not imply the amount is taxable wages. Its function is to provide the employee and the Health Insurance Marketplace with the data to correctly calculate any premium tax credit.