Section 105 plans made easy
As an employer or human resources professional, you need to know the best options for providing benefits to your employees and how each type of benefit works. One type of employee benefit that is growing in popularity is a Section 105 plan. This complete guide will give you everything you need to know about Section 105 plans.
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Is a Section 105 plan right for your organization?
This guide will provide a general overview of Section 105 plans so that you can make the best benefits decisions for your organization.
Topics covered in this guide include:
What is a Section 105 plan?
A Section 105 plan is an IRS-approved health benefit that allows the tax-free reimbursement of medical and insurance expenses, as described under Section 105 of the Internal Revenue Code (IRC).
Employers use Section 105 plans in a variety of ways. For example, a common type of Section 105 plan is a self-funded health benefit, where the employer reimburses employees for qualified health expenses rather than paying premiums to an insurance company.
How does a Section 105 medical reimbursement plan work?
Section 105 plans are simple in practice:
- The employer must establish a formally written Section 105 plan
- The employer determines a monthly or annual allowance they want to make available to each employee during a period of coverage (generally a year) and other terms of the plan
As employees submit eligible expenses, the employer reviews the expenses to verify they are eligible (this step is often outsourced to a third-party administrator or benefits administration software like PeopleKeep). The employer then reimburses the employees 100% tax-free up to the allowance cap set in the previous step.
Benefits of Section 105 plans
While there are many benefits to offering a Section 105 plan to employees, two of the primary reasons are cost savings and tax advantages.
Employers commonly provide a Section 105 plan for cost savings over a traditional group health insurance plan. With a self-funded health plan like a Section 105 plan, employers reimburse employees for health benefits rather than paying premiums to an insurance company.
Employers choose to self-fund their health benefits because it allows them to save the profit margin that an insurance company adds to its premium for a fully-insured plan. Plus, employers have control over their allowance amounts. This gives employers complete cost control over their benefits, avoiding yearly rate increases.
With a Section 105 plan, employers and employees don't have to pay taxes on reimbursed expenses. Many employers who don't qualify for or can't afford group health insurance often resort to offering taxable wage increases. In these cases, employers can save money by reimbursing employees through this type of plan because payroll and income taxes aren't applied.
Organizations such as limited liability companies (LLCs), C-corporations, and partnerships can also take a full tax deduction of Section 105 plans as long as they satisfy the requirements. This includes deducting the cost of health insurance and dental insurance premiums, qualified long-term care insurance, out-of-pocket medical, dental, and vision care expenses, and other eligible expenses paid to employees.
On top of it all, a Section 105 plan doesn't have to be a standalone benefit. Employers already offering a group health plan can offer a Section 105 alongside the group plan, and there are a few ways to do that, depending on your needs.
Types of Section 105 plans
Section 105 plans can go by a few different names. Each type of plan has differences in how they're used. However, they all operate similarly, where an employer reimburses or contributes to healthcare expenses.
Types of Section 105 plans include:
- Health reimbursement arrangements (HRAs)
- Qualified small employer HRA (QSEHRA)
- Individual coverage HRA (ICHRA)
- Group coverage HRA (GCHRA), also known as an integrated HRA
- Excepted benefit HRA (EBHRA)
- Medical expense reimbursement plans (MERPs)
- Accident and health plans
Flexible spending accounts (FSAs) for eligible medical costs
Pros of Section 105 plans
When evaluating Section 105 plans, there are many advantages to offering them.
Section 105 plans are extremely flexible for employers. You can design the plan in various ways to meet your budget, health benefit, and hiring needs. For example, employers can decide the amount to contribute to employees' health reimbursement allowances. They can even offer different amounts to different classes of employees depending on the type of plan selected.
Employers can also choose which expenses are eligible for reimbursements, such as only insurance premiums or all eligible expenses.
For employees, Section 105 plans such as HRAs allow for personalized care. Your employees can choose their type of insurance plan and provider and only request reimbursement for the expenses that are most important to them.
Cost controls and savings
With Section 105 plans, the employer owns the funds and the plan. Section 105 reimbursements are only issued to employees once they show proof of a valid medical expense. Additionally, unused funds stay with the employer when the employee leaves an organization.
With traditional group health insurance plans, the expenses can change every year, and rate hikes are not uncommon. But with a Section 105 plan, employers set spending limits.
This gives employers complete control over the benefits spending.
Employers can also save money thanks to tax deductions. Using a Section 105 plan reduces the amount of federal insurance contribution act tax (FICA) and federal unemployment tax (FUTA) an employer pays. Employers can deduct reimbursements as a business expense and exclude them from wages subject to FUTA and the employer portion of FICA. And reimbursements are generally excluded from employees' gross income.
Recruitment and employee retention
Many organizations struggle to provide affordable health insurance. Because of their cost savings and predictability, Section 105 plans help employers offer more robust health benefits. This is a big bonus for recruiting and retaining key employees.
Additionally, the rise in healthcare consumerism has resulted in more employees seeking benefits that are personalized to their needs. With a Section 105 plan, you can accommodate the various needs of your diverse workforce.
Cons of a Section 105 plan
While Section 105 plans are excellent options for most organizations, they may not be the best option for everyone. This section will cover some potential cons to offering these plans.
These benefits may be unfamiliar
Offering a Section 105 plan is a different approach for many employers and employees. Some employers perceive the hassle and risk of fines as a con of offering a Section 105 plan.
Additionally, many employees will be unfamiliar with how these plans work compared to group health insurance, resulting in a steeper learning curve.
However, benefits administration software such as PeopleKeep can help alleviate these concerns. With our software solutions, you can set up and manage your HRA in just minutes each month. Plus, our knowledgeable team will review submitted expenses for compliance.
Learn how PeopleKeep's software works by watching an on-demand demo
Limited to no tax benefits for some types of owners
Some business owners receive limited or no tax benefits from reimbursements through the business, while others can't participate directly in a Section 105 plan.
Employers can offer their employees a Section 105 plan with all organization types. However, business owner eligibility and tax benefits can differ.
C-corporations can deduct Section 105 expenses, and owner-employees are also eligible to participate. For partnerships (and LLCs filing as a partnership), you can only get coverage as a business owner through spousal employment (a spouse who is also an employee). S-corporations, however, have restrictions on taxes and owner eligibility. Sole proprietors owners are also generally ineligible for tax-free reimbursements.
Additional compliance regulations
Section 105 plans are group health plans and are subject to compliance with the IRS, ERISA, HIPAA, ACA, and other applicable federal and state rules. As such, some employers perceive compliance as a con. However, you can use a Section 105 software administrator to ensure your arrangement is compliant.
Design requirements for Section 105 plans
Here are some rules regarding Section 105 plans:
- A Section 105 plan is paid for solely by the employer and cannot be funded through employee salary deductions
- A Section 105 plan may only reimburse employees during their effective dates in the plan.
- A Section 105 plan can reimburse for eligible medical expenses and health insurance premium amounts
- Employees must substantiate each eligible healthcare expense. PeopleKeep's software helps employers perform this function, saving you time and money
- Reimbursements are generally excludable from the employee's gross income under Internal Revenue Code Sections 105 and 106
- Section 105 plans are considered group health plans and, as such, must be designed and administered to comply with the IRS, HIPAA, ERISA, COBRA, and the ACA
Section 105 plans compliance
Since Section 105 plans are considered group health plans, they must comply with IRS, HIPAA, COBRA, ERISA, and ACA rules.
There are a few IRS rules you need to be aware of:
- Plan documents: The IRS requires that written plan documents are established and maintained. Plan documents define what expenses are eligible for reimbursement, the amount of employer contribution, and other required details about the reimbursement plan.
- Expense documentation: The IRS requires that employees submit proper documentation verifying their claim for reimbursement and that supporting documentation is saved on file for ten years. This often takes the form of receipts and doctor's notes.
- Non-discrimination: Section 105 plans must comply with IRS nondiscrimination rules. The rules state the plan must not discriminate in favor of highly compensated individuals (HCIs) with respect to eligibility to participate in the plan or benefits provided under the plan.
Health Insurance Portability and Accountability Act (HIPAA) rules
Section 105 plans are governed by HIPAA privacy rules. To administer a plan correctly, the entity processing employee reimbursement claims receives protected health information (PHI) that is required to be held confidentially under HIPAA.
Consolidated Omnibus Budget Reconciliation Act (COBRA) rules
COBRA rules only apply to organizations with 20 or more employees. Employers must give terminated employees the option to continue their participation in the Section 105 plan for a period after termination and may charge an employee up to 102% of the value of their allowance if COBRA is elected.
Employee Retirement Income Security Act (ERISA) rules
There are a couple of ERISA rules you need to know:
- Summary plan description: Section 105 plans are employee welfare plans under ERISA. It requires every welfare plan to have a summary plan description (SPD) and to furnish copies to each participant.
- General ERISA compliance: The federal government has specific regulations employers must comply with to reimburse employees for individual health insurance premiums without triggering ERISA plan status for the individual health insurance policies. For example, the employer must not endorse specific individual health insurance policies or pay directly for them.
Affordable Care Act (ACA) rules
- Preventive care compliance: Section 2713 of the PHS Act, as added by the ACA, requires group health plans (including Section 105 plans) to cover basic preventive health services without cost-sharing.
- Dependent coverage for adult children up to age 26: Section 2714 of the PHS Act, as added by the ACA, provides that group health plans (including Section 105 plans) that make available dependent coverage of children must make such coverage available for children until 26 years of age.
- Form 720 & Patient-Center Outcomes Research Institute (PCORI) fee: The ACA includes a "research fee" that plan sponsors must pay on an annual basis annually via Form 720.
- 60-day notice of material modification: The ACA requires employers to provide 60 days of advanced notice to participants when making material modifications to their group health plan (including Section 105 plans).
Health reimbursement arrangements (HRAs)
One of the most common types of Section 105 plans is the HRA. These are sometimes referred to as health reimbursement plans, health reimbursement accounts, and reimbursement health plans. With an HRA, you can reimburse your employees for their medical care expenses, such as individual health insurance premiums and out-of-pocket expenses.
Choosing the right HRA for your organization can be complicated, so we've broken it down with our HRA comparison chart.
HRA comparison chart
|Business size restrictions||Limited to businesses with fewer than 50 FTE employees.||None.||None.|
|Allowance amount restrictions||QSEHRA allowances are limited to $5,450 for self-only employees and $11,050 for employees with a family in 2022. Businesses cannot give different employees different allowance amounts based on criteria other than family status.||None.||None.|
|Group health policy requirements||Can't be offered with a group health policy.||Can be offered with a group health policy, but employees cannot have a choice between the group policy and the HRA.||Must be offered with a group health policy.|
|Are individual health policies permitted?||Yes.||Yes; in fact, they're required to participate in the HRA.||No.|
|Premium tax credit coordination requirements||Employees must reduce their premium tax credit by the amount of their HRA allowance.||Employees cannot collect premium tax credits and participate in the ICHRA. However, if the ICHRA allowance is considered unaffordable, employees may waive the HRA and collect the credits.||N/A. These HRAs can't reimburse employees for individual premiums.|
|Annual rollover permitted||Yes, but it can't exceed the federal annual maximum for the year.||Yes.||Yes.|
|Medical expenses available for reimbursement||Any or all items listed in IRS Publication 502.||Any or all items listed in IRS Publication 502.||Any or all items listed in IRS Publication 502 except for insurance premiums.|
|Employee eligibility guidelines||All full-time employees are eligible. Businesses can decide on part-time employee eligibility.||Businesses can decide on eligibility based on 11 different employee classes.||None.|
Frequently Asked Questions
What is a Section 105 plan?
A Section 105 plan is an employer-sponsored health plan that allows organizations to provide tax-free reimbursement of employees’ medical and health insurance expenses, as allowed under Section 105 of the Internal Revenue Code (IRC). The most common form of Section 105 plan is a health reimbursement arrangement (HRA).
Is a Section 105 reimbursement plan considered health insurance?
No. A Section 105 plan is not health insurance. Rather, it’s a tax-free way to reimburse medical and health insurance expenses, as allowed by Section 105 of the IRS code. However, for federal compliance, it is considered a group health plan. A Section 105 plan qualifies as minimum essential coverage (MEC) for applicable large employers (ALEs).
Can business owners participate in a Section 105 plan?
Almost all business owners can participate in a Section 105 plan, except for S Corporation owners and shareholders with more than 2% ownership in the organization. See our article on owner eligibility.
What is the difference between a Section 105 plan and an HSA?
The most significant difference between Section 105 plans and health savings accounts (HSAs) is that the business owns the reimbursement arrangement (Section 105 plan) while the employee owns the HSA. In addition, with a Section 105 plan, employers only make reimbursements after expenses have occurred, whereas an HSA is a pre-funded account that the employee owns.
To learn more, see our article on HRAs vs. HSAs.
Can I have a Section 105 plan and an HSA at the same time?
Yes! Unique rules apply to users, especially regarding what items are available for reimbursement when an HSA is in place. To learn more, read our article on using HRAs and HSAs.
What can a Section 105 plan reimburse?
Section 105 plans can be used to reimburse many health care products and services, including the following types of insurance premiums, provided they were not already paid with pre-tax dollars: COBRA premiums, dental insurance premiums, individual health insurance premiums, long-term care premiums, Medicaid/CHIP insurance premiums, Medicare Part A & B premiums, Medicare supplement insurance premiums, Multiplan insurance premiums, prescription insurance premiums, short term medical insurance, TRICARE insurance premiums, and vision insurance premiums.
Section 105 plans can also reimburse your employees for qualifying out-of-pocket medical expenses. To see the complete list, see our IRS Publication 502 eligible expense tool.