The term Section 105 HRA refers to a specific type of employer-sponsored health benefit, governed by U.S. tax law under § 105 of the Internal Revenue Service (IRS) rules. More precisely, it pertains to a health reimbursement arrangement (“HRA”) that allows an employer to reimburse employees for eligible medical expenses on a tax-advantaged basis.
Here’s a breakdown of how such a plan works, why it matters, and key compliance issues to keep in mind.
What is a Section 105 HRA?
A Section 105 HRA is an employer-funded arrangement under which:
The employer sets up the plan and funds it (employees do not contribute via salary reduction).
The plan reimburses eligible medical or health-care expenses incurred by the employee (and often spouse, dependents) in accordance with §213(d) of the tax code.
Reimbursements are typically tax-free to the employee (i.e., not included in the employee’s gross income) provided the arrangement qualifies.
Why employers use Section 105 HRAs
Tax efficiency: Employers can deduct contributions to the HRA as a business expense, and employees generally receive reimbursements tax-free (subject to proper substantiation).
Flexibility: The employer has latitude to design the HRA (within regulatory constraints) for example setting eligible expenses, annual reimbursement limits, etc.
Benefit offering: It can be an attractive employee benefit especially for small businesses seeking to provide health-care support without full insurance plan burdens.
Key compliance and design considerations
When implementing a Section 105 HRA plan, several rules are critical:
Eligible participants: The plan must restrict reimbursements to eligible employees (and eligible dependents). If the plan reimbursements include ineligible individuals (such as a domestic partner who is not a tax dependent) and the value is not properly included in income, the plan may fail and all reimbursements become taxable.
No cash-outs: The plan cannot allow employees to withdraw unused balances in cash or treat the HRA like a general savings account. That would endanger the tax-favoured status.
Non-discrimination: The plan must not discriminate in favour of highly compensated employees with respect to eligibility or benefits. For group health plans, nondiscrimination under §105(h) must be considered.
Plan documentation and operation: There must be a written plan document, and the administration (claims adjudication, eligible expense substantiation) must follow the rules.
Practical tips for employers
Before launching, decide the scope: who is eligible (employees, spouses, dependents), what expenses qualify, annual reimbursement limits, plan year, carry-over rules if any.
Ensure proper record-keeping: maintain documentation of eligible medical expenses, reimbursement decisions, and keep plan records.
Review whether the arrangement will trigger nondiscrimination testing and whether that is acceptable.
Communicate clearly to employees: what is covered, how to submit claims, any endpoints after termination, etc.
Conclusion
A Section 105 HRA is a powerful tool for employers to offer health-care reimbursement benefits in a tax-efficient way. However, the benefits depend heavily on proper design and ongoing compliance with IRS rules. Missteps — such as allowing improper participants, cash-outs, or failing nondiscrimination requirements — can lead to the plan losing its tax-favoured status and rendering reimbursements taxable. For employers considering inclusion of such HRA plans alongside other group health benefits, careful planning and administrative diligence are key.
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