What Is a Section 105 Plan?

A Section 105 plan is an employer-sponsored arrangement that reimburses employees for medical expenses without those reimbursements being taxed as income. The authority is IRC §105(b), which excludes reimbursements of expenses incurred for medical care as defined at IRC §213(d). Health Reimbursement Arrangements, ICHRAs, QSEHRAs and self-insured medical expense reimbursement plans are all Section 105 plans.

Section 105 is the load-bearing wall under this entire category. Every tax-free medical reimbursement an employer makes traces back to it. Here is what the section actually says, how it differs from Section 125, and what a plan has to do to stay inside it.

What Section 105 Actually Says

Most summaries skip the structure of the statute, and the structure is the interesting part.

One neighbour is worth naming before the structure: IRC §106 excludes the coverage an employer provides from the employee’s income, while §105 governs what the plan then pays out. The two work as a pair, and a §105 plan almost always sits inside a §106 arrangement.

§105(a) is the bad news. It provides the general rule: amounts received by an employee through accident or health insurance for personal injuries or sickness are included in gross income, to the extent the amounts are attributable to employer contributions that were not included in the employee’s income, or were paid by the employer. In other words, the default is taxable.

§105(b) is the exception that everything runs on. It excludes from gross income amounts paid, directly or indirectly, to reimburse the taxpayer for expenses incurred for medical care as defined at IRC §213(d), for the employee, their spouse, their dependents, and any child of the employee who has not attained age 27 as of the end of the taxable year.

§105(c) handles a separate case — payments for permanent loss or loss of use of a member or function of the body, or permanent disfigurement. To be excluded these must be computed with reference to the nature of the injury and without regard to how long the employee is absent from work. Both halves of that test are required.

That ordering matters more than it looks. The exclusion is a carve-out from a rule that taxes these payments by default. A plan does not get the exclusion by intending to; it gets it by satisfying §105(b) on the facts. Amounts received under such a plan that fall outside §105(b) and §105(c) land back on §105(a) and are taxable compensation. Amounts that were never received under an accident or health plan at all are simply income under §61.

Section 105 vs Section 125: They Do Different Jobs

This is the most common confusion in the category, and it comes from treating the two sections as competing options. They are not alternatives. Most real plans use both, because each supplies something the other does not.

Section 105 is the exclusion. It answers: when the plan pays a medical reimbursement, is that payment taxable to the employee? §105(b) says no, if it reimburses §213(d) medical care.

Section 125 is the funding mechanism. It answers a different question: can an employee choose between taxable cash and a nontaxable benefit without being taxed on the choice itself? Absent §125, the doctrine of constructive receipt would tax an employee who could have taken cash, whether or not they did. §125 suspends that result for a defined menu of qualified benefits.

Read together: §125 lets the money go in pre-tax, and §105 lets it come back out tax-free. An HRA uses §105 without §125, because it is employer-funded and the employee never had a choice to tax. A health FSA uses both. So does a self-insured medical expense reimbursement plan funded by salary reduction.

One consequence worth stating plainly, because CPAs ask about it: under Proposed Treasury Regulation §1.125-1(b), amounts an employee elects to contribute by salary reduction under a §125 cafeteria plan are treated as employer contributions to the accident and health plan. That is not a reading invented for any particular product. It is the mechanism that has made pre-tax health insurance deductions work since 1978.

Section 105(h): The Nondiscrimination Rules

A self-insured Section 105 plan cannot disproportionately favor the people who run the company. IRC §105(h) and Treasury Regulation §1.105-11 impose two tests: eligibility and benefits.

The consequence of failing is narrower than most people expect, and worth knowing before it scares anyone off. A plan that discriminates does not lose its status, and rank-and-file participants are not affected. Instead, highly compensated individuals include their “excess reimbursement” in gross income. The penalty lands on the people the plan favored.

These rules apply to self-insured arrangements specifically. That is a design constraint on owner-heavy and closely held companies in particular, and it is the first thing a competent administrator tests.

What a Section 105 Plan Requires

Four requirements separate a plan from an expensive mistake.

A written plan document, adopted in advance. Treasury Regulation §1.105-11 requires a separate written plan for the benefit of employees. Reimbursing a bill first and papering it later does not create a plan.

Reimbursement limited to §213(d) medical care. Diagnosis, cure, mitigation, treatment or prevention of disease, or affecting a structure or function of the body. General wellness and lifestyle spending does not qualify on its own.

Substantiation by someone other than the claimant. Under the cafeteria plan substantiation rules at Proposed Treasury Regulation §1.125-6(b), no claim is reimbursable until substantiated by information from an independent third party. Self-certification does not satisfy it, and neither does sampling a subset of claims.

Payment that is not made irrespective of expenses incurred. Treasury Regulation §1.105-2 is the test that actually decides these cases: §105(b) does not apply where the employee would receive payment irrespective of whether or not the employee incurs expenses for medical care. An arrangement that pays a fixed amount for completing an activity fails. One that reimburses documented care does not.

The Types of Section 105 Plan

Every arrangement below draws its tax treatment from §105. They differ in who funds them and which rules carve them out from the general restriction on standalone arrangements.

• Health Reimbursement Arrangement (HRA) — the general-purpose form, established in Revenue Ruling 2002-41 and Notice 2002-45. Employer-funded only.
• Integrated HRA — offered alongside a group health plan and coordinated with it, which IRS Notice 2013-54 made the ordinary route for active employees after the Affordable Care Act.
• Individual Coverage HRA (ICHRA) — available since January 1, 2020, reimbursing individual market premiums and medical expenses instead of offering a group plan.
• Qualified Small Employer HRA (QSEHRA) — created by the 21st Century Cures Act in December 2016 for employers under 50 full-time equivalents with no group health plan, subject to annual caps.
• Health FSA — funded by employee salary reduction under §125, with the reimbursement excluded under §105.
• Self-insured medical expense reimbursement plan (SIMERP), also written SIMRP — a §105(b) plan funded through a §125 election and designed to sit alongside existing coverage. The two spellings are explained at SIMRP or SIMERP? Why You Will See Both.

How these compare side by side, including which combinations can be held at once, is at MERP vs HRA vs FSA vs Section 125.

Section 105 and the Self-Employed

Section 105 requires an employee, and a sole proprietor is not their own employee. Partners in a partnership and more-than-2% S corporation shareholders are likewise treated as self-employed for these purposes and generally cannot participate in a §105 plan on their own behalf.

The long-standing route around this is employing a spouse who works genuinely in the business and covering the family through that employee. Note where it does not work: in an S corporation, IRC §318 attributes the shareholder’s stock to their spouse, which makes the spouse a more-than-2% shareholder too and closes the route. Where it is available it is heavily fact-dependent and has been litigated more than once — the employment has to be real, documented and compensated. This is a question for your own tax advisor rather than a plan vendor.

Where SIMERP Fits

SIMERP is a Section 105(b) plan funded through a §125 cafeteria plan election, reimbursing §213(d) medical care delivered by licensed physicians through a virtual care clinic, and designed to layer alongside an existing health plan rather than replace it. Employees keep their current coverage, doctors and deductible.

The employer saving comes from the payroll tax that stops applying when compensation moves as a medical reimbursement instead of as wages — the treatment IRS Publication 15 (Circular E) states directly in Section 5, and which IRC §3121(a)(2) grounds. On published program figures it averages $640 per enrolled employee per year, net of program costs.

Whether the exclusion holds for a given design is the whole ballgame, and the analysis is at Is SIMERP Legal? The Definitive Guide to SIMERPs.

Primary Sources

• IRC §105 — amounts received under accident and health plans. (a) the general inclusion rule, (b) the medical reimbursement exclusion, (c) permanent loss payments, (h) nondiscrimination for self-insured plans.
• IRC §106 — exclusion for employer-provided coverage.
• IRC §125 — cafeteria plans and the pre-tax election.
• IRC §213(d) — the definition of medical care. See IRS Publication 502: What’s Actually Reimbursable.
• IRC §3121(a)(2) — the payroll-tax wage exclusion.
• Treasury Regulation §1.105-2 — the “irrespective” test.
• Treasury Regulation §1.105-11 — self-insured plan definition, written-plan requirement and the §105(h) tests.
• Proposed Treasury Regulation §1.125-1(b) — salary reduction treated as employer contribution.
• Proposed Treasury Regulation §1.125-6(b) — third-party substantiation.
• Revenue Ruling 2002-41 and Notice 2002-45 — the guidance establishing HRAs.
• IRS Notice 2013-54 — ACA integration.
• IRS Publication 15 (Circular E), Section 5 — payroll-tax treatment.

Your Next Step

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