Self-Employed HRA: Your Options and How to Set One Up

A Health Reimbursement Arrangement (HRA) is an employer-funded plan that reimburses employees for out-of-pocket medical costs and, in some cases, health insurance premiums. Businesses use these plans to help employees cover healthcare expenses. Employer contributions are not included in an employee’s taxable income, providing a tax-advantaged way to manage medical spending.

HRA Eligibility for Self-Employed Business Structures

Under IRS rules, a self-employed individual, such as a sole proprietor with no other staff, cannot establish an HRA for their own benefit. This same restriction applies to partners in a partnership. These business owners cannot receive tax-free reimbursements from an HRA in the same way a common-law employee can.

A sole proprietor can gain access to HRA benefits by hiring their spouse as a W-2 employee. The business can then establish an HRA for its employee. The spouse can enroll in the HRA, and the plan can be structured to cover their family, which includes the self-employed business owner and any dependents. This makes the owner a beneficiary of their spouse’s employee benefit, allowing them to receive tax-free reimbursements.

The spouse’s employment must be genuine. This means the spouse must perform actual services for the business, receive reasonable compensation, and be treated as a W-2 employee. The work should be documented with a job description, and compensation should be paid regularly. Maintaining records like timesheets can help substantiate the employment relationship.

In a C-Corporation, the owner is considered an employee and can participate in an HRA on a tax-favored basis. S-Corporation owners who hold more than 2% of the company’s stock face different treatment. While they can be W-2 employees, they are not eligible to participate in an HRA on a tax-free basis, and any reimbursements they receive would be considered taxable income.

Eligible businesses have two primary options: the Qualified Small Employer HRA (QSEHRA) and the Individual Coverage HRA (ICHRA). A QSEHRA is for employers with fewer than 50 full-time equivalent employees that do not offer a group health plan and has annual, IRS-mandated contribution limits.

The ICHRA is available to businesses of any size and has no annual contribution limits, offering greater flexibility. An ICHRA can be offered to different classes of employees with varying benefit amounts, while a QSEHRA must be offered on the same terms to all. To receive tax-free reimbursements from an ICHRA, the employee must be enrolled in a qualifying individual health insurance plan.

Information and Decisions for Plan Setup

The first step is to select the appropriate type of HRA, either a QSEHRA or an ICHRA, based on the business’s size and needs. The business must then determine the reimbursement allowance. For a QSEHRA, this involves setting an amount that does not exceed the IRS limits. For 2025, those limits are $6,350 for self-only coverage and $12,800 for family coverage. An ICHRA has no government-imposed caps, giving the employer control over the allowance.

The business must also define which expenses are eligible for reimbursement. The plan can cover only health insurance premiums or be expanded to include all qualified medical expenses as defined by the IRS. These expenses are detailed in IRS Publication 502, “Medical and Dental Expenses,” and include costs like deductibles, copayments, and prescription drugs.

Formal plan documents are a legal requirement. The business must prepare a written Plan Document, which is the comprehensive legal text, and a Summary Plan Description (SPD), a reader-friendly summary for employees. These documents must contain specific details such as:

• The legal name and Employer Identification Number (EIN) of the business
• The official name of the plan and its start date
• The eligibility requirements for employees
• The monthly allowance amounts
• The specific medical expenses that are reimbursable
• The procedures for submitting and substantiating claims

Templates for these documents can be sourced from benefits consultants or generated through specialized HRA administration software.

Implementing and Managing Your HRA

The plan is legally established when the business owner signs and dates the Plan Document. These signed documents should be kept on file for legal proof and reference.

After adoption, the business must provide a written HRA notice to every eligible employee, including the spouse-employee in a sole proprietorship. For an ICHRA, this notice must be provided at least 90 days before the beginning of the plan year. The notice must include the permitted benefit amount, the plan’s start date, and information about how the HRA may affect eligibility for premium tax credits.

Ongoing administration involves managing reimbursement requests. An employee incurs a medical expense and submits a claim with proof of the expense, such as a receipt or an explanation of benefits. The business or its third-party administrator (TPA) must then substantiate the claim. This involves verifying the expense is qualified under the plan and that adequate proof of payment was provided. Once verified, the business issues the reimbursement. Many businesses use HRA administration software or a TPA to handle these tasks.

Tax Treatment and Reporting Requirements

For the business, reimbursements made through a compliant HRA are 100% tax-deductible as a business expense. This deduction lowers the business’s taxable income and is claimed on its annual tax return.

For the employee, reimbursements for qualified medical expenses are generally tax-free and not subject to federal income or payroll taxes.

IRS reporting requirements differ by HRA type. For a business offering a QSEHRA, the employer must report the total permitted benefit amount on each employee’s annual Form W-2 in Box 12 using the code “FF”. The reported figure is the total amount the employee was eligible to receive, not the amount actually reimbursed.

An ICHRA does not have the same W-2 reporting requirement. For an employee to receive tax-free ICHRA reimbursements, they must be enrolled in a qualifying individual health insurance plan or Medicare. The employee must attest to having this coverage each year and with each reimbursement request. If an employee receives a QSEHRA reimbursement for any month in which they did not have minimum essential coverage, that reimbursement becomes taxable income.