What Is a MERP? Medical Expense Reimbursement Plans Explained

A MERP is a Medical Expense Reimbursement Plan: a written, employer-sponsored plan that pays employees back for qualified medical expenses, tax-free. The employer deducts what it contributes, the employee owes no income tax on what they receive, and the reimbursement is exempt from payroll tax. HRAs, ICHRAs, QSEHRAs and health FSAs are all MERPs.

The acronym confuses people because MERP is a category, not a product. Several benefits you already know are MERPs wearing different names. Here is the whole landscape, what the rules actually require, and how the varieties differ.

What a MERP Is

A Medical Expense Reimbursement Plan is an arrangement in which an employer agrees, in writing and in advance, to reimburse employees for medical expenses they incur, up to stated limits and under stated rules.

Its tax treatment comes from two sections of the Internal Revenue Code that have been in place since 1954:

• IRC §106 excludes employer-provided coverage under an accident or health plan from the employee’s gross income.
• IRC §105(b) excludes the reimbursements themselves, when they reimburse expenses incurred for medical care as defined at IRC §213(d).

The employer side is ordinary: contributions are generally deductible as an ordinary and necessary business expense under IRC §162. The payroll-tax side is the part most people miss. Medical care reimbursements paid under a self-insured medical reimbursement plan are not wages, so they do not carry Social Security, Medicare or FUTA tax — the rule stated plainly in IRS Publication 15 (Circular E), Section 5, and grounded in the wage exclusion at IRC §3121(a)(2).

That is the entire economic engine of every MERP: money moves from employer to employee to pay for medical care without being taxed as compensation on the way through.

The Requirements Every MERP Has to Meet

A MERP is not an informal habit of paying people back. Four things separate a plan from a liability.

It has to be in writing, and it has to exist first. Treasury Regulation §1.105-11 requires a separate written plan for the benefit of employees, adopted before the expenses it reimburses. Reimbursing a medical bill and papering it afterward does not work.

It can only reimburse medical care. IRC §213(d) defines medical care as amounts paid for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting a structure or function of the body. General wellness spending, fitness and lifestyle costs fall outside that definition unless they meet it on their own facts.

Expenses have to be substantiated by someone other than the employee. A plan that pays on the participant’s own say-so is the failure mode the IRS looks for. Under the cafeteria plan substantiation rules at Proposed Treasury Regulation §1.125-6(b), no claim is reimbursable until it is substantiated by information from an independent third party. Self-certification does not satisfy it. The IRS restated the same expectation in CCA 202317020 (April 2023), which is worth reading if an administrator proposes reviewing a sample of claims rather than all of them.

It cannot pay irrespective of whether or not the employee incurs expenses for medical care. This is the test that decides cases. Treasury Regulation §1.105-2 provides that §105(b) does not apply where the employee would receive the payment irrespective of whether or not the employee incurs expenses for medical care. Fixed cash for completing an activity fails this test. Reimbursement of documented medical care does not.

There is a fifth requirement that catches owner-heavy companies: because a MERP is self-insured, the nondiscrimination rules of IRC §105(h) and Treasury Regulation §1.105-11 apply. A plan that disproportionately benefits highly compensated individuals does not lose its status, but those individuals pick up the excess reimbursement as taxable income.

Is a MERP Insurance?

No. This is the single most common misunderstanding, and it has consequences.

A MERP is self-insured, which means the employer’s plan bears the obligation directly. There is no carrier, no premium being paid to a third party to assume risk, and no insurance product involved. That is why the tax analysis runs through §105 rather than through insurance rules, and it is why a MERP cannot be evaluated using standards written for insured products.

It also means a MERP is generally not a substitute for major medical coverage. Most MERPs are designed to sit alongside a health plan, not to replace one.

The Types of MERP You Will Encounter

Every arrangement below is a MERP. The differences are in who funds it, what it can pay for, and which rules carve it out from the general prohibition on standalone arrangements.

Health Reimbursement Arrangement (HRA). The general-purpose MERP, established in guidance issued in June 2002 — Revenue Ruling 2002-41 and Notice 2002-45. Funded solely by the employer, with no employee salary reduction. Unused amounts may carry forward if the plan allows.

Integrated HRA. An HRA offered alongside a group health plan and coordinated with it. After the Affordable Care Act, guidance in IRS Notice 2013-54 made clear that an HRA offered to active employees generally has to be integrated with group coverage, because a standalone arrangement would run into the ACA’s annual dollar limit and preventive services requirements. Integration is the ordinary route.

Individual Coverage HRA (ICHRA). Available since January 1, 2020 under the 2019 tri-agency final rule. Instead of offering a group plan, the employer reimburses employees for individual market premiums and medical expenses. The employee must be enrolled in individual coverage, and the offer has to be made on the same terms within defined employee classes.

Qualified Small Employer HRA (QSEHRA). Created by the 21st Century Cures Act in December 2016 for employers with fewer than 50 full-time employees, counting full-time equivalents, that offer no group health plan. Employer-funded only, subject to annual statutory caps that are indexed each year.

Self-insured medical expense reimbursement plan (SIMERP), also written SIMRP. A §105(b) plan funded through a §125 cafeteria plan election — which is still an employer-funded plan for this purpose, because a salary reduction election under §125 is treated as an employer contribution and designed to sit alongside existing coverage rather than replace it. Covered below, and in detail at SIMRP or SIMERP? Why You Will See Both.

MERP vs HRA vs FSA vs HSA

The fastest way to keep these straight is to ask three questions: who funds it, who owns it, and what happens to what is left over.

MERP is the category. Every item below except the HSA is one: a health FSA is itself a self-insured medical reimbursement plan, funded differently from an HRA but drawing its exclusion from the same section.

HRA — employer funds it, employer owns it, and unused amounts stay with the employer when the employee leaves. Employees cannot contribute. It is a MERP.

FSA — the employee funds it through a pre-tax salary reduction under IRC §125, subject to an annual limit indexed each year. Use-it-or-lose-it applies, softened by a limited carryover or a grace period if the plan adopts one. Employer contributions are permitted but uncommon.

HSA — not a MERP at all. An HSA is an individually owned trust account under IRC §223. It requires enrollment in a qualified high-deductible health plan, the money belongs to the employee permanently, it is portable across jobs, and it can be invested. Either the employer or the employee may contribute.

The practical distinction that matters at renewal: an HSA is the employee’s asset, an FSA is the employee’s money on a deadline, and an HRA or other MERP is the employer’s promise to pay medical costs the employee actually incurs.

What a MERP Can Reimburse

The universe is IRC §213(d), and the working list most administrators use is IRS Publication 502. It covers doctor and specialist care, hospital and facility charges, prescriptions, dental, vision, hearing, mental health treatment, medical equipment and supplies, and travel undertaken primarily for medical care.

One trap worth naming, because most published summaries get it wrong: Publication 502 is written for the itemized medical expense deduction, and plan reimbursement rules are not identical to it. The clearest divergence is over-the-counter drugs, which have been reimbursable from an FSA, HSA or HRA without a prescription since the CARES Act in 2020, but are still not deductible under Publication 502. Use Publication 502 as the map, not as the plan document.

The categorized breakdown, including what is excluded and where the two lists part company, is at IRS Publication 502: What’s Actually Reimbursable.

Who Actually Saves, and How

Both sides of the payroll save, for different reasons.

The employer saves its share of FICA on every dollar that moves as a medical reimbursement rather than as wages, and deducts the contribution. On a plan funded through a §125 election, that saving is immediate and mechanical: it shows up on the first payroll run after launch, because it is a reduction in a tax the company was already remitting.

The employee avoids income tax and their own FICA share on the same dollars, and receives care that would otherwise have been paid for with post-tax money.

Neither saving depends on a forecast. That is the difference between a MERP and most benefits proposals: the money is already leaving the building, and the plan changes the tax character of it.

Where SIMERP Fits

SIMERP is one implementation of a MERP, built for employers who already have a health plan and are not looking to replace it.

It is a self-insured medical expense reimbursement plan under IRC §105(b), funded through a §125 cafeteria plan election, reimbursing §213(d) medical care delivered by licensed physicians. It layers alongside existing coverage. Employees keep their current plan, their current doctors and their current deductible.

What it produces, on published program figures: an average of $640 per enrolled employee per year in net employer savings, from an average of $93.33 per employee per month in FICA reduction less program costs. It is built for employers with 25 or more W-2 employees, and implementation runs 30 to 60 days.

Whether that is worth doing at your headcount is an arithmetic question, and it takes about three minutes to answer.

How to Verify This Yourself

Everything above is sourced to public material. Hand this list to your CPA rather than handing them a brochure.

• IRC §105 — amounts received under accident and health plans.
• IRC §106 — exclusion for employer-provided coverage.
• IRC §125 — cafeteria plans and pre-tax salary reduction elections.
• IRC §213(d) — the definition of medical care.
• IRC §223 — health savings accounts, for contrast.
• IRC §3121(a)(2) — the payroll-tax wage exclusion for medical care payments.
• Treasury Regulation §1.105-2 — the “irrespective” test.
• Treasury Regulation §1.105-11 — self-insured plan definition, written-plan requirement, §105(h) nondiscrimination.
• Proposed Treasury Regulation §1.125-6(b) — third-party substantiation.
• Revenue Ruling 2002-41 and Notice 2002-45 — the guidance that established HRAs.
• IRS Notice 2013-54 — ACA integration of HRAs.
• IRS Publication 15 (Circular E), Section 5 — payroll-tax treatment.
• IRS Publication 502 — the medical expense list.

Your Next Step

If you want the number for your own company rather than the category average, the Savings Assessment takes three minutes and books your next step on the screen straight after — a 20 minute Discovery Call at 50 or more W-2 employees, or the live group briefing below that.

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