If you’re a business owner paying thousands of dollars in out-of-pocket medical expenses, you may be missing out on a valuable tax deduction.
Even after paying your health insurance premiums, expenses like deductibles, prescriptions, dental work, and copays can add up quickly. And while you might assume these costs are deductible on your personal tax return, the IRS has limits on how much you can actually deduct.
That’s where a Section 105 Medical Reimbursement Plan may help.
With the right business structure, this strategy can allow you to reimburse qualified medical expenses through your business, potentially turning personal healthcare costs into legitimate business deductions.
Let’s break down how it works, who qualifies, and when it makes financial sense.
TL;DR: What You Need to Know
- A Section 105 plan can turn qualifying medical expenses into business deductions. Eligible businesses may deduct reimbursements while employees receive them tax-free.
- Your business structure matters. Sole proprietors, C corporations, partnerships, and S corporations have different eligibility rules.
- Married business owners may have an opportunity to hire their spouse. A legitimate spouse-employee arrangement can potentially provide qualifying medical benefits for the family.
- High medical costs make this strategy more attractive. Annual out-of-pocket expenses above $5,000 are a useful planning benchmark, not an IRS requirement.
- Documentation is essential. You’ll need a compliant written plan, supporting medical records, and proper reimbursement procedures.
- Savings can be significant. In a simplified example, $50,000 in qualifying reimbursements could generate approximately $17,000 in tax savings, depending on your tax situation.
What Is a Section 105 Medical Reimbursement Plan?
A Section 105 medical reimbursement plan is an employer-sponsored arrangement that allows a business to reimburse employees for qualifying medical expenses.
You may also hear it called a Medical Expense Reimbursement Plan (MERP) or, depending on how it’s structured, a Health Reimbursement Arrangement (HRA).
The idea is simple: instead of an employee paying for all eligible medical costs with after-tax income, the business reimburses those expenses through a qualifying employee benefit plan.
When the arrangement meets the applicable requirements, the business may deduct the reimbursement, and the employee generally doesn’t have to include it in taxable income.
The reimbursement can potentially cover qualifying expenses for the employee, their spouse, and eligible family members.
However, not every business owner can participate as an employee, and different reimbursement arrangements have different rules.
Why aren’t medical expenses automatically deductible?
Many business owners assume that if they spend $20,000 on medical expenses, they’ll receive a $20,000 deduction on their personal tax return.
Unfortunately, that’s not how the personal medical expense deduction works.
The IRS generally allows you to deduct qualifying unreimbursed medical expenses on Schedule A only to the extent that they exceed 7.5% of your adjusted gross income (AGI). You must also itemize deductions to benefit from this provision.
For example, suppose you have:
| Item | Amount |
|---|---|
| Adjusted gross income | $200,000 |
| Qualified medical expenses | $20,000 |
| 7.5% of your AGI | $15,000 |
| Potential medical expense deduction | $5,000 |
Even though you spent $20,000 on medical care, only $5,000 exceeds the IRS threshold.
And if your total itemized deductions don’t exceed your standard deduction, those expenses may not provide any additional tax savings.
This is why deducting medical expenses as a business owner is worth exploring.
A properly structured reimbursement arrangement may provide a business deduction without relying on the personal medical expense deduction threshold.
You can learn more about these limitations in IRS Publication 502: Medical and Dental Expenses.
How Does a Section 105 Medical Reimbursement Plan Work?
The process involves setting up a qualifying plan, identifying eligible employees, documenting medical expenses, and reimbursing those costs through the business.
Here’s what that looks like.
Step 1: Set up a written reimbursement plan
Your business needs a written plan document explaining how the medical reimbursement arrangement operates.
The document should identify who qualifies, which expenses are covered, how employees request reimbursement, and what records must be maintained.
The arrangement must also comply with applicable federal health plan rules. Simply writing down a reimbursement policy doesn’t automatically make it compliant.
Step 2: Determine who can participate
This is where your business structure becomes important.
For example, if you’re married and operate a sole proprietorship, you may be able to establish a legitimate employment relationship with your spouse.
Your spouse could then participate in a qualifying employee medical reimbursement plan, potentially covering eligible expenses for your family.
If you’re an eligible employee of a C corporation, you may also be able to participate in a qualifying employer-sponsored arrangement.
However, sole proprietors generally cannot treat themselves as employees for this purpose, and S corporation owners have special restrictions.
We’ll cover these differences below.
Step 3: Track qualified medical expenses
Once the plan is established, the eligible employee submits qualifying medical expenses for reimbursement.
These may include:
- Medical deductibles and copays
- Prescription medications
- Dental and vision expenses
- Chiropractic treatment
- Mental health care
- Certain over-the-counter medical products
- Other qualifying healthcare expenses
The expense must meet the applicable IRS definition of medical care and the terms of your reimbursement plan.
For a more detailed breakdown, refer to IRS Publication 502.
Step 4: Reimburse the employee
Let’s say your spouse is a legitimate employee of your business and is covered by the plan.
Your spouse incurs a qualifying $2,000 hospital expense and submits the supporting documentation.
The business reviews the expense and reimburses your spouse $2,000 according to the plan’s procedures.
When properly structured, that reimbursement may qualify as a deductible employee benefit expense for the business and tax-free income for your spouse.
The important part is that you’re following an established plan rather than simply paying personal medical bills out of your business account.
How Much Can You Save With a Section 105 Plan?
The potential savings become more noticeable when your household has significant out-of-pocket medical expenses.
Let’s use an example involving $50,000 in annual qualifying medical expenses, separate from your insurance premiums.
Suppose you have a properly established reimbursement plan and your business can deduct the full $50,000.
For illustration, we’ll assume the deduction produces tax savings at a combined effective marginal rate of 34%.
| Item | Amount |
|---|---|
| Qualified medical expenses | $50,000 |
| Business deduction | $50,000 |
| Illustrative tax rate | 34% |
| Estimated tax savings | $17,000 |
| Effective after-tax medical cost | $33,000 |
The calculation is:
$50,000 × 34% = $17,000 in estimated tax savings.
Your household still incurs the $50,000 in medical expenses. However, the deduction may reduce the amount of taxes you pay.
Without the reimbursement plan, you might only receive a limited personal medical expense deduction, depending on your adjusted gross income and whether you itemize.
This example is simplified. The $17,000 isn’t a guaranteed savings amount, and the actual benefit depends on your tax rate, entity structure, deductible expenses, and any additional costs required to maintain the plan.
You also need to consider whether your business has enough qualifying income and whether the employment and reimbursement arrangement satisfies the applicable rules.
The more qualifying medical expenses you have, the more worthwhile this strategy may become.
Who Qualifies for a Section 105 Medical Reimbursement Plan?
One of the biggest factors in determining eligibility is how your business is structured.
Sole proprietors and single-member LLCs
If you’re self-employed as a sole proprietor or own a single-member LLC taxed as a sole proprietorship, you generally cannot establish a Section 105 plan solely to reimburse your own expenses as an employee.
However, married business owners may have another option.
If your spouse performs legitimate work for your business, you may be able to employ them and establish a qualifying medical reimbursement plan.
Your spouse must actually perform business services, and the employment arrangement must be properly supported.
For example, your spouse might handle bookkeeping, administrative work, customer service, or other legitimate responsibilities.
The plan may then reimburse qualifying expenses for your spouse and eligible covered family members, potentially including you.
C corporation owners
A C corporation may offer more flexibility because an owner who is genuinely employed by the corporation can potentially participate in employer-sponsored medical benefits.
This may make a C corporation worth evaluating when you’re single and have significant recurring medical expenses.
However, forming a C corporation solely to obtain this deduction isn’t automatically a good decision.
You also need to consider corporate taxes, compensation requirements, administrative costs, and how the business operates.
S corporation owners
S corporations have special limitations.
If you own more than 2% of an S corporation, you generally cannot receive the same tax-free Section 105 reimbursement treatment available to regular employees.
There are separate rules for shareholder health insurance premiums, but those rules don’t automatically allow tax-free reimbursement of all out-of-pocket medical expenses.
For some business owners, a separate legitimate business may provide another planning opportunity.
For example, an owner with an S corporation and a distinct business activity might evaluate whether that activity could operate through a different qualifying structure.
However, this requires genuine business operations and careful tax planning. Simply moving income between entities doesn’t automatically create an eligible reimbursement arrangement.
The IRS guidance on S corporation medical insurance explains the special treatment of shareholder health benefits.
What if you have other employees?
This particular owner-focused strategy is generally easier to evaluate when the business has no unrelated employees.
If you employ additional workers, you may need to consider the Affordable Care Act’s group health plan requirements, eligibility rules, and nondiscrimination provisions.
You should also consider employees in other businesses under common ownership.
For businesses with employees, other arrangements, such as QSEHRAs or individual coverage HRAs, may be more appropriate.
When Does a Medical Reimbursement Plan Make Sense?
You have more than $5,000 in annual medical expenses
A useful planning benchmark is to consider the strategy when your household regularly incurs more than $5,000 in qualifying out-of-pocket medical expenses.
This amount isn’t an official IRS threshold. It’s a general guideline for determining whether the potential savings justify the additional work.
As medical expenses increase to $10,000, $20,000, or more, the potential deduction may become more valuable.
Your family has ongoing healthcare costs
Some families experience a single expensive medical year, while others face recurring expenses.
For example, you might have ongoing costs for prescriptions, specialist appointments, dental treatment, or other qualifying medical care.
If you expect those costs to continue, a properly established plan may provide tax benefits over multiple years.
Your business already has a qualifying structure
The strategy may be easier to implement if you already have an eligible employee arrangement.
For instance, if your spouse genuinely works in your sole proprietorship, establishing a qualifying reimbursement plan may be more practical than creating a new business entity.
Your business can maintain proper records
Medical reimbursement plans require documentation.
If you’re already maintaining organized bookkeeping, employment records, and business expenses, the additional tracking may be manageable.
When Is a Section 105 Plan Not Worth It?
Although the potential savings are attractive, this strategy isn’t appropriate for everyone.
You have low medical expenses. If your household spends less than $5,000 annually on qualifying medical care, the savings may not justify the setup and ongoing administrative costs.
You don’t have an eligible employment arrangement. A sole proprietor cannot simply reimburse themselves as an employee. Similarly, hiring a spouse without real business responsibilities doesn’t establish a legitimate employee benefit arrangement.
You would need to create an unnecessary business entity. Forming a corporation or restructuring business income can introduce additional tax obligations and administrative costs.
You have other employees. Additional employees may trigger health plan compliance requirements that make an owner-focused arrangement unsuitable.
The best approach is to calculate your estimated tax savings first, then compare those savings against the cost and complexity of operating the plan.
What Documentation Is Required for a Section 105 Plan?
Proper implementation is one of the most important parts of this strategy.
A business cannot simply begin reimbursing personal medical expenses and expect every payment to qualify as a deduction.
You need records supporting both the employee relationship and the reimbursement arrangement.
1. Written plan document
Your business should maintain a compliant written document establishing the terms of the reimbursement plan.
It should explain employee eligibility, covered medical expenses, reimbursement procedures, and any applicable limitations.
2. Employment agreement and job description
If you’re using a spouse-employee arrangement, document the employment relationship.
Your spouse needs to perform legitimate work for the business, and the overall compensation arrangement must be reasonable and properly supported.
A written employment agreement and job description can help establish these facts.
3. Timesheets or task logs
Keep records showing the actual services performed.
These records can help demonstrate that your spouse is genuinely working in the business rather than being listed as an employee solely for tax purposes.
4. Receipts and reimbursement records
You should retain documentation supporting each qualifying expense.
For example, suppose your spouse submits several qualifying medical expenses totaling $7,000.
Your records should show the individual expenses, supporting medical documentation, approved reimbursement amounts, and payments made by the business.
A reimbursement log helps organize this information and supports the deduction if the IRS reviews your return.
5. Proper tax reporting
Qualifying medical reimbursements must be recorded correctly on your business tax return.
Depending on your business structure, employee benefit expenses may be reported on:
- Schedule C, Line 14: Employee benefit programs
- Form 1065, Line 19: Employee benefit programs
- Form 1120, Line 24: Employee benefit programs
Rental businesses may have different reporting considerations depending on the nature of the activity and employment arrangement.
These categories aren’t automatic authorization to deduct owner medical expenses. Your business must first qualify for the deduction.
Your tax professional should confirm the proper reporting based on your business and the applicable tax year’s forms.
Hidden Costs and Responsibilities of a Medical Reimbursement Plan
Before implementing a reimbursement plan, consider the expenses and obligations that come with it.
Plan setup and administration
You may need professional assistance preparing the plan documents, reviewing eligibility, and establishing the reimbursement process.
There may also be ongoing fees for plan administration and compliance.
Form 720 and the PCORI fee
Certain medical reimbursement arrangements are subject to the Patient-Centered Outcomes Research Institute (PCORI) fee.
When applicable, the plan sponsor reports and pays this fee using IRS Form 720.
The fee is generally calculated based on the number of covered lives and the rate applicable to the plan year.
For plan years ending on or after October 1, 2025, and before October 1, 2026, the applicable rate is $3.84 per covered life.
The PCORI fee is generally reported annually by July 31 of the following calendar year, rather than filed with your income tax return.
Not every reimbursement arrangement is subject to the fee, so confirm the requirements for your plan.
You can find additional information in the IRS Instructions for Form 720.
Ongoing documentation
You’ll need to track eligible expenses, maintain supporting records, and follow the plan’s reimbursement procedures.
These responsibilities continue every year the plan is active.
Business restructuring costs
If you’re considering establishing another entity to support a reimbursement arrangement, account for any additional registration, accounting, payroll, tax filing, and compliance costs.
The overall financial benefit should justify these expenses.
Section 105 Medical Reimbursement Plan Checklist
Before implementing this strategy, ask yourself:
- Do I have substantial out-of-pocket medical expenses beyond my health insurance premiums?
- Are these expenses likely to continue in future years?
- Does my current business structure support a qualifying plan?
- If I’m married, does my spouse perform legitimate services for my business?
- Do I have other employees or related businesses that could affect eligibility?
- Can I properly document the employment relationship and medical reimbursements?
- Have I compared the potential tax savings with the setup and ongoing administration costs?
- Have I reviewed the plan’s compliance and tax reporting requirements with a qualified professional?
These questions can help you determine whether a medical reimbursement plan deserves a closer look.
Conclusion: Should You Set Up a Section 105 Medical Reimbursement Plan?
If you’re spending thousands of dollars every year on out-of-pocket healthcare costs, it may be worth exploring whether your business can help cover those expenses more tax-efficiently.
A Section 105 Medical Reimbursement Plan can potentially turn qualifying medical expenses into deductible employee benefits while providing tax-free reimbursements.
For business owners with significant or recurring medical costs, the potential savings can be substantial.
However, the strategy depends on your business structure, employee eligibility, and proper implementation.
Before setting up a plan, review your actual medical expenses, calculate the potential deduction, and consider the associated costs.
The goal is to make sure the strategy provides a meaningful tax benefit for your specific situation rather than following a general recommendation that may not apply to your business.
Find Out Where Else Your Business Could Be Saving on Taxes
A medical reimbursement plan is just one of the many tax-saving opportunities available to eligible business owners.
If you’re wondering whether you’re taking advantage of all the deductions and strategies available to your business, start with our free Tax Savings Scorecard.
Answer a few questions about your business to identify potential areas where you may be missing tax-saving opportunities.
Take the Free Tax Savings Scorecard
If you’d like help evaluating and implementing tax-saving strategies, visit TaxElm to learn how our tax professionals can help.
Frequently Asked Questions About Section 105 Medical Reimbursement Plans
1. What is a Section 105 medical reimbursement plan?
A Section 105 medical reimbursement plan is an employer-sponsored arrangement that reimburses eligible employees for qualified healthcare expenses. When properly structured, the business may deduct those reimbursements while the employee receives them tax-free. The plan must meet the applicable tax and health plan requirements.
2. Can a self-employed person use a Section 105 plan?
A self-employed sole proprietor generally cannot establish a Section 105 plan solely to reimburse their own medical expenses as an employee. However, married business owners may have an opportunity to establish a qualifying arrangement for a spouse who genuinely works in the business. Eligibility depends on the business structure and the employment relationship.
3. Can an S corporation owner establish a medical reimbursement plan?
An S corporation shareholder who owns more than 2% of the company generally cannot receive tax-free Section 105 medical reimbursements as an eligible employee. Separate rules apply to certain shareholder health insurance arrangements. Some owners may have other planning opportunities through a distinct qualifying business, but those arrangements require careful review.
4. Can I hire my spouse to qualify for a Section 105 plan?
Certain business owners can establish a qualifying medical reimbursement arrangement for a spouse who legitimately works in the business. Your spouse must perform actual services, and the employment and compensation arrangements must be properly documented. Simply listing your spouse as an employee without meaningful work doesn’t qualify.
5. What medical expenses qualify under a Section 105 plan?
Eligible expenses may include deductibles, copays, prescription medications, dental care, vision care, and certain other healthcare costs. The expenses must meet the applicable IRS definition of medical care and be covered by the plan. IRS Publication 502 provides guidance on qualifying medical expenses.
6. How much money can a Section 105 plan save?
Savings depend on the amount of qualifying medical expenses, the allowable business deduction, and your tax situation. For example, a $50,000 qualifying deduction at an illustrative 34% tax rate could produce approximately $17,000 in tax savings. Actual savings vary and may be reduced by administrative costs or other tax considerations.
7. Is there a maximum reimbursement amount for a Section 105 plan?
Section 105 doesn’t establish a universal annual dollar cap for all qualifying medical reimbursements. However, the specific plan may have limits, and certain types of HRAs have additional legal restrictions. All reimbursements must be eligible, properly documented, and compliant with applicable requirements.
8. Can I deduct medical expenses personally if my business reimburses them?
You generally cannot claim a personal medical expense deduction for costs that have already been reimbursed tax-free through your business. The IRS doesn’t allow you to receive duplicate tax benefits for the same expense. Accurate records help ensure expenses are reported correctly.
9. Do I need to file Form 720 for a Section 105 plan?
Certain medical reimbursement arrangements are subject to the PCORI fee, which is reported using Form 720. When applicable, the fee is generally reported and paid annually by July 31 following the plan year. Your filing requirement depends on the type of arrangement and its coverage.
10. Is a Section 105 medical reimbursement plan worth it for small business owners?
A Section 105 medical reimbursement plan may be worthwhile if you have substantial qualifying medical expenses, an eligible employee arrangement, and enough potential tax savings to justify the costs. Annual expenses above $5,000 can be a useful starting point for evaluating the strategy, although this isn’t an IRS threshold. The best decision depends on your business structure, tax situation, and expected healthcare expenses.