A medical reimbursement plan is any plan or arrangement under which an employer reimburses an employee for uninsured health or accident expenses incurred by the employee or his dependents. Health or accident expenses in this context are defined in Internal Revenue Code Section 213. The most common type of Section 105 plan is a self-funded health plan, where the employer has chosen not to insure health care benefits and to self-fund these benefits rather than pay premiums to an insurer. Section 105 plans are also frequently found inside Section 125 Cafeteria Plans in the form of Medical Flexible Spending Accounts (FSAs). It is permissible, however, to implement a medical reimbursement plan alongside a conventional health insurance plan (to reimburse amounts not covered by insurance) and outside of a cafeteria plan.

What are the advantages of Section 105 plans?

Section 105 plans offer advantages to both the employer and the employees. The medical expense reimbursements are tax deductible by the employer and the employer has flexibility in the design of the plan's provisions, such as establishing maximums amounts for reimbursement and setting eligibility requirements for participation. The biggest advantage to employees is that the plan's reimbursement payments are not considered to be taxable income to the employees, provided that they have not taken a medical expense deduction for these amounts on their personal tax return.

Can the employer administer the Section 105 plan?

The short answer is yes, but we do not recommend self-administration for two reasons – first, correctly determining whether expenses meet the criteria under Code Section 213 for reimbursement requires extensive knowledge, creating the risk of noncompliance due to improper reimbursements; secondly, when the employer must deny a reimbursement request, it can generate an adversarial situation between employer and employee which is not desirable. EmCentrix offers administration services for such plans at a very reasonable cost.

What are the requirements for Section 105 plans?

The principal requirements to qualify under Section 105 are to adopt a written plan document, all participants must be employees, expenses to be reimbursed must not be subject to reimbursement under any health insurance policy, and the plan must meet the nondiscrimination requirements specified under the Code. In addition, if employee contributions are made under the plan, these become plan assets subject to ERISA and must be held in trust, pursuant to a written trust instrument.

What are the nondiscrimination requirements under Section 105?

The plan must not discriminate in favor of highly compensated employees with respect to eligibility to participate or benefits provided under the plan.

A plan discriminates as to eligibility unless it benefits:

1. 70% or more of all employees, or
2. 80% or more of all employees eligible to benefit under the plan, if 70% or more of all employees are eligible to benefit under the plan, or
3. A group of employees described in IRC Section 410(b)(2)(A)(I) that is found to be a nondiscriminatory classification in accordance with Prop. Treas. Reg. 1.410(b)- For these purposes, there may be excluded from consideration any employees who have not completed three years of service, part-time employees whose customary weekly employment is less than 35 hours, employees covered by a collective bargaining agreement, and nonresident aliens.

A medical reimbursement plan will not discriminate as to benefits if the type and amount of benefits available to highly compensated participants and their dependents are also available on the same basis for all other participants and their dependents. This test is applied by looking at available benefits rather than actual benefit payments under the plan.

Who are highly compensated employees?

A highly compensated employee meets one of these tests:

1. Is one of the five highest-paid officers of the employer
2. Is a shareholder who owns directly or indirectly more than 10% in value of the employer's stock
3. Is in the top 25% of highest paid employees

What happens if the plan is discriminatory?

If the plan is discriminatory, then all or part of the medical benefits paid for the benefit of a highly compensated employee will be taxable to that employee.

   IRS Links

   IRS Pub 502 Medical & Dental Deductible Expenses

   IRS Pub 503 Child and Dependent Care Expenses