For CFOs and financial decision-makers evaluating tax-advantaged health benefit strategies, IRS Section 105 represents the bedrock upon which Self-Insured Medical Reimbursement Plans (SIMRP) and WIMPER programs are built. This section of the Internal Revenue Code, codified in 1954 and refined through decades of IRS rulings and regulations, creates the legal framework allowing employers to provide medical expense reimbursements that are deductible to the employer while being excluded from employee taxable income.
Yet despite its 70-year history and substantial financial benefits, Section 105 remains poorly understood by many business leaders. This comprehensive guide demystifies Section 105, explaining its key provisions, compliance requirements, interaction with related tax code sections, and recent IRS guidance that shapes modern plan design.
IRS Code Section 105, formally titled “Amounts received under accident and health plans,” governs the tax treatment of employer-provided health benefits, particularly self-insured medical reimbursement arrangements. The code establishes when and how medical expense reimbursements can be excluded from an employee’s gross income, creating favorable tax treatment for both parties.
[Source: Internal Revenue Code Section 105, 26 U.S.C. § 105]
The heart of Section 105’s tax advantages lies in subsection (b), titled “Amounts expended for medical care.” This provision states:
Gross income does not include amounts paid, directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses incurred for the medical care (as defined in Section 213(d)) of the taxpayer, spouse, or dependents (as defined in Section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof).
[Source: Internal Revenue Code Section 105(b), 26 U.S.C. § 105(b)]
Breaking this down into plain language:
This exclusion creates the foundation for the triple tax advantage: the employer deducts the expense, the employee excludes it from income, and neither party pays FICA taxes on these amounts.
Section 105’s structure creates three distinct tax benefits when properly implemented:
Under Section 162 (ordinary and necessary business expenses), employer contributions to Section 105 plans are fully deductible as business expenses, reducing the company’s taxable income.
[Source: Internal Revenue Code Section 162, 26 U.S.C. § 162]
Section 105(b) excludes qualified medical reimbursements from the employee’s gross income. Unlike regular wages, these reimbursements don’t appear in Box 1 of Form W-2, meaning employees pay no federal income tax on these amounts.
When implemented through a Section 125 cafeteria plan with salary reduction agreements, both the employer and employee avoid FICA taxes (Social Security 6.2% + Medicare 1.45% = 7.65%) on contributed amounts.
Financial Impact:
For an employee contributing $1,220 monthly ($14,640 annually):
For a 100-employee company: $112,000 in total annual FICA tax savings
For a 200-employee company: $224,000 in total annual FICA tax savings
[Source: IRS Publication 15 (Circular E), Employer’s Tax Guide 2024; Social Security Administration]
Section 105 doesn’t operate in isolation. Understanding its relationship with related Internal Revenue Code sections is critical for compliant plan design.
Section 105(b) explicitly references Section 213(d) to define what constitutes “medical care.” Section 213(d) states:
“The term ‘medical care’ means amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.”
[Source: Internal Revenue Code Section 213(d), 26 U.S.C. § 213(d)]
The IRS publishes and regularly updates Publication 502 (Medical and Dental Expenses), which provides an extensive list of qualified medical expenses under Section 213(d). These include:
Importantly, insurance premiums for medical care are also considered qualified medical expenses under Section 213(d), allowing Section 105 plans to reimburse certain insurance costs.
[Source: IRS Publication 502, Medical and Dental Expenses, 2024]
Section 125, titled “Cafeteria plans,” allows employees to choose between cash compensation and qualified benefits on a pre-tax basis. When a Section 105 plan is offered through a Section 125 cafeteria plan:
[Source: Internal Revenue Code Section 125, 26 U.S.C. § 125]
Critical Requirement: Section 125 requires a formal written plan document maintained by the employer that meets specific requirements and regulations. Informal arrangements do not qualify for tax-advantaged treatment.
Section 106(a) provides that gross income does not include employer-provided coverage under an accident or health plan. This section specifically states:
“Gross income of an employee does not include employer-provided coverage under an accident or health plan.”
[Source: Internal Revenue Code Section 106(a), 26 U.S.C. § 106(a)]
The IRS Office of Chief Counsel has confirmed in multiple memorandums that wellness programs providing medical care (as defined under Section 213(d)) are generally excluded from an employee’s gross income under Section 106(a) when funded with pre-tax dollars through a Section 125 cafeteria plan.
[Source: IRS Chief Counsel Memorandum 201703013, dated January 20, 2017]
This coordination between Sections 105, 106, 125, and 213 creates the complete legal framework for tax-advantaged medical reimbursement programs.
While Section 105(b) provides generous tax benefits, Section 105(h) imposes strict non-discrimination rules to prevent these benefits from being offered exclusively to highly compensated individuals.
Section 105(h) requires self-insured medical reimbursement plans to satisfy two distinct tests:
The plan must benefit one of the following groups:
[Source: Internal Revenue Code Section 105(h)(3), 26 U.S.C. § 105(h)(3)]
The plan must provide all benefits to all participants on the same terms. Highly compensated individuals cannot receive proportionally greater benefits than non-highly compensated employees.
[Source: Internal Revenue Code Section 105(h)(4), 26 U.S.C. § 105(h)(4)]
For purposes of Section 105(h), highly compensated individuals include:
[Source: Internal Revenue Code Section 105(h)(5), 26 U.S.C. § 105(h)(5); Treasury Regulation §1.105-11(d)]
If a plan fails either test, excess reimbursements provided to highly compensated individuals must be included in their taxable income. The plan doesn’t lose its qualified status entirely—non-highly compensated employees continue to receive tax-free benefits—but highly compensated individuals lose the tax advantage on amounts exceeding what non-highly compensated employees receive.
[Source: Internal Revenue Code Section 105(h)(7), 26 U.S.C. § 105(h)(7)]
Section 105(h) allows certain employee categories to be excluded when performing non-discrimination testing:
[Source: Treasury Regulation §1.105-11(c)(2)]
IRS Publication 15 (Circular E), the Employer’s Tax Guide, provides clear guidance on the tax treatment of Section 105 medical reimbursements:
“Medical care reimbursements. Generally, medical care reimbursements paid for an employee under an employer’s self-insured medical reimbursement plan aren’t wages and aren’t subject to social security, Medicare, and FUTA taxes, or income tax withholding.”
[Source: IRS Publication 15 (Circular E), Employer’s Tax Guide 2024, Page 12]
This official IRS guidance confirms that when properly structured:
However, the publication includes an important caveat: “See Pub. 15-B for a rule regarding inclusion of certain reimbursements in the gross income of highly compensated individuals.” This references the Section 105(h) non-discrimination requirements.
The IRS has issued several important memorandums in recent years clarifying Section 105’s application to modern wellness programs and fixed indemnity arrangements. CFOs must understand these rulings to ensure compliant plan design.
This recent memorandum clarified that fixed indemnity health plans paired with wellness programs funded by pre-tax contributions create taxable events when payments are made to employees rather than as reimbursements for actual medical expenses.
Key holding: Under Section 105(b), a wellness plan may not be paired with an indemnity plan that pays money directly to employees while using pre-tax dollars to fund the indemnity payments. Such arrangements create taxable income because the exclusion under Section 105(b) applies only to reimbursements for actual medical expenses, not fixed payments regardless of expenses incurred.
[Source: IRS Chief Counsel Memorandum 202323006, Release Date: June 9, 2023]
Implication for WIMPER and SIMRP Programs:
Properly structured programs avoid this issue by:
This memorandum addressed whether cash rewards paid to employees for participating in a wellness program could be excluded from income under Sections 105 or 106 if premium contributions were made pre-tax through a Section 125 cafeteria plan.
Key holding: Cash rewards paid to employees for wellness program participation are not excludable from gross income under Sections 105 or 106 and are therefore taxable. However, reimbursements of premiums used for medical care under Section 213(d) are excludable.
[Source: IRS Chief Counsel Memorandum 201622031, dated April 14, 2016]
Implication: Wellness incentives must be structured as reimbursements for qualified medical expenses, not as cash rewards for participation, to maintain tax-favored treatment.
This memorandum concluded that benefits paid under an employer-provided self-funded health plan are taxable income if:
Key holding: Wellness plans independently qualify as accident and health plans under Section 106, and contributions through a Section 125 cafeteria plan are pre-tax. Flex credits awarded under a wellness plan are nontaxable if used to purchase qualified benefits but are taxable if used to purchase nonqualified benefits.
[Source: IRS Chief Counsel Memorandum 201719025, dated April 24, 2017]
Implication: Plans must be structured as legitimate insurance arrangements with risk transfer, not merely as compensation mechanisms disguised as health benefits.
Properly implementing a Section 105 plan requires satisfying multiple regulatory requirements beyond the non-discrimination rules.
ERISA Section 402(a)(1) requires every employee benefit plan to be established and maintained pursuant to a written instrument. The plan document must specify:
[Source: ERISA Section 402(a)(1), 29 U.S.C. § 1102(a)(1)]
Every reimbursement must be substantiated to verify it represents a qualified medical expense under Section 213(d). IRS Revenue Ruling 2003-43 and Notice 2002-45 establish documentation requirements:
[Source: IRS Revenue Ruling 2003-43; IRS Notice 2002-45]
Acceptable documentation includes:
Credit card receipts alone are generally insufficient—documentation must clearly identify the medical nature of the expense.
Section 105 plans must be carefully coordinated with other benefit arrangements to avoid prohibited duplication or coverage issues:
With HSAs: Health Savings Accounts require enrollment in a high-deductible health plan and generally prohibit “other coverage.” Section 105 plans can be structured as limited-purpose plans (dental/vision only) or post-deductible plans to preserve HSA eligibility.
[Source: IRS Revenue Ruling 2004-45; IRS Notice 2004-50]
With Group Health Plans: Standalone Section 105 plans that are group health plans face ACA market reform restrictions (annual and lifetime limit prohibitions). Most compliant implementations integrate Section 105 plans with ACA-compliant group health plans or structure them as excepted benefits.
[Source: ACA Section 2711; 45 CFR §147.126]
Applicable Large Employers (50+ full-time equivalent employees) must comply with ACA reporting requirements:
[Source: Internal Revenue Code Sections 6055 and 6056]
Additionally, Section 105 plans subject to ERISA must provide:
[Source: ERISA Sections 101, 102, 503]
Understanding Section 105’s theoretical framework is valuable, but seeing how it operates in practice clarifies its power. WIMPER and SIMRP programs leverage Section 105’s provisions systematically:
Section 125 Cafeteria Plan: Employees make salary reduction elections to fund benefits on a pre-tax basis, reducing taxable wages and creating immediate FICA savings.
Section 105(b) SIMERP: A Self-Insured Medical Expense Reimbursement Plan document outlines how employees access benefits and receive reimbursements for qualified Section 213(d) medical expenses.
Section 213(d) Qualified Services: The program provides or reimburses actual medical services including telehealth, prescriptions, preventive care, chronic disease management, and wellness services.
100-Employee Company:
Additionally, employees in the 22% federal tax bracket save:
For the company’s 100 employees, total employee federal tax savings exceed $500,000 annually, demonstrating Section 105’s substantial impact when properly implemented.
CFOs should be aware of common mistakes that can jeopardize Section 105 tax advantages:
Problem: Accepting credit card receipts or generic invoices without verifying the medical nature of expenses.
Solution: Implement rigorous substantiation procedures requiring itemized documentation showing provider, service, date, patient, and amount. Use third-party administrators or benefits platforms to verify compliance.
Problem: Offering enhanced benefits exclusively to executives or highly compensated employees without extending comparable benefits to rank-and-file employees.
Solution: Conduct annual non-discrimination testing under Section 105(h) and adjust plan design to satisfy both eligibility and benefits tests. Document testing results for IRS audit protection.
Problem: Providing fixed cash amounts to employees regardless of whether they incur actual medical expenses, resembling compensation rather than reimbursement.
Solution: Structure plans as true reimbursement arrangements requiring incurrence and substantiation of qualified Section 213(d) medical expenses before payment. Never pay fixed amounts without corresponding medical costs.
Problem: Operating informal arrangements without written plan documents, adoption agreements, or employee communications.
Solution: Create comprehensive written plan documents satisfying ERISA Section 402 requirements, have the employer formally adopt the plan, and provide Summary Plan Descriptions to participants.
Problem: Offering Section 105 plans alongside HSAs, group health plans, or other arrangements without considering interaction effects and compliance implications.
Solution: Work with benefits counsel to structure integrated programs that satisfy Section 105, ERISA, HIPAA, and ACA requirements simultaneously. Consider limited-purpose or post-deductible designs when coordinating with HSAs.
For financial decision-makers evaluating benefit strategies, Section 105 offers unique advantages that distinguish it from other tax-advantaged health arrangements:
Unlike HSAs (which require HDHPs) or HRAs (which have specific contribution limits and eligibility restrictions), Section 105 plans offer substantial design flexibility:
The 7.65% FICA savings on every contributed dollar creates an immediate, measurable return that compounds annually. Unlike investment returns that fluctuate with markets, FICA savings represent guaranteed tax reduction that flows directly to the bottom line.
Employees receive a 30-40% effective discount on healthcare expenses through combined federal income tax, FICA, and state tax savings. This makes benefits more affordable and valuable without increasing employer net cost.
Tax-advantaged medical benefits differentiate employers in competitive labor markets. The ability to provide enhanced healthcare value without proportional cost increases creates a sustainable competitive advantage.
When structured properly (unlike the fixed indemnity arrangements criticized in recent IRS memorandums), Section 105 plans offer ironclad legal footing backed by 70 years of tax code history and extensive IRS guidance.
Section 105 was codified in 1954 as part of the Internal Revenue Code and has remained substantially unchanged for 70 years. Its provisions have been upheld consistently through thousands of IRS rulings, court decisions, and administrative interpretations. This extensive history provides substantial legal certainty for employers implementing Section 105 plans.
Yes, but with important limitations. S-corporation shareholders owning more than 2% of the company are treated as partners rather than employees for fringe benefit purposes. Section 105 benefits provided to them are generally taxable unless specific requirements are met. However, non-shareholder employees of S-corporations can fully participate in Section 105 plans with complete tax advantages.
[Source: Internal Revenue Code Section 1372; IRS Notice 2008-1]
Section 105 plans must comply with ACA market reforms, particularly prohibitions on annual and lifetime limits. Most compliant structures either: (1) integrate the Section 105 plan with an ACA-compliant group health plan, or (2) structure the Section 105 plan as an excepted benefit (limited to dental/vision, or a wellness program under specific conditions). Standalone Section 105 plans providing comprehensive medical benefits generally cannot satisfy ACA requirements.
[Source: ACA Section 2711; 45 CFR §147.126; IRS Notice 2013-54]
The plan doesn’t lose its qualified status entirely. Instead, excess reimbursements provided to highly compensated individuals (beyond what non-highly compensated employees receive) must be included in the HCIs’ taxable income. Non-highly compensated employees continue receiving tax-free benefits. The employer should correct the discriminatory provisions for future years to avoid ongoing issues.
[Source: Internal Revenue Code Section 105(h)(7)]
Yes, in certain circumstances. Section 213(d) includes “amounts paid for insurance covering medical care” as qualified medical expenses. However, reimbursement of individual health insurance premiums may trigger ACA market reform issues for group health plans. The safest approach is reimbursing premiums for excepted benefits (dental, vision, specified disease policies) or integrating premium reimbursements within an ACA-compliant group health plan structure.
[Source: Internal Revenue Code Section 213(d); ACA guidance]
The IRS doesn’t specify a required testing frequency, but best practice is annual testing using the last day of the plan year as the testing date. This ensures compliance and provides documentation for potential IRS audits. If the employer’s workforce composition changes significantly mid-year (merger, acquisition, mass hiring), interim testing may be prudent.
[Source: Treasury Regulation §1.105-11(c)]
Yes, but carefully. Section 105(h) permits classification of employees for eligibility purposes if the classification is nondiscriminatory. However, once an employee is eligible, all participants must receive benefits on the same terms (benefits test). You can’t provide higher reimbursement limits to highly compensated individuals than to non-highly compensated employees. Different classes (full-time vs. part-time, salaried vs. hourly) can have different plans, but each plan must satisfy non-discrimination testing independently.
[Source: Treasury Regulation §1.105-11(c)]
Employers should maintain indefinitely:
The general IRS statute of limitations is three years, but certain issues (fraud, substantial understatement) can extend indefinitely. Retaining comprehensive documentation protects against audits and provides evidence of good-faith compliance.
IRS Section 105 represents more than an obscure provision of the tax code—it’s the legal architecture enabling some of the most powerful tax-advantaged benefit strategies available to American employers. With $112,000+ in annual FICA savings for a typical 100-employee company and substantial employee tax benefits, Section 105’s impact on both employer financials and employee compensation is profound.
For CFOs evaluating benefit strategies, understanding Section 105 provides the foundation for making informed decisions about SIMRPs, WIMPER programs, and related tax-advantaged health arrangements. The code’s 70-year history, extensive IRS guidance, and clear compliance framework offer legal certainty rarely found in newer tax provisions.
The key to successful Section 105 implementation lies in three principles:
By mastering Section 105’s requirements and opportunities, financial decision-makers position their organizations to offer competitive, tax-efficient benefits that create measurable value for both the company and its employees.