Individual Coverage HRA (ICHRA) and Health Reimbursement Arrangements — The Most Powerful Health Insurance Deduction Strategy for Small Business Owners in 2026
Health Reimbursement Arrangements under IRC §105 and §106 allow employers to reimburse employees for individual health insurance premiums and qualified medical expenses on a 100% tax-free basis. The Individual Coverage HRA (ICHRA), available since January 1, 2020 under IRS Notice 2019-45 and final regulations, removes the prior dollar limits and allows businesses of any size to offer tax-free health benefits without offering a group health plan. For S-corporation owners, sole proprietors, and small business owners who have been paying health insurance premiums out-of-pocket or through inefficient structures, the ICHRA and QSEHRA represent one of the most significant untapped deduction opportunities in the tax code.
Understanding the HRA Framework: How IRC §105 and §106 Create Tax-Free Health Benefits
A Health Reimbursement Arrangement is an employer-funded account from which an employer reimburses employees for qualified medical expenses, including individual health insurance premiums. The tax treatment is governed by two IRC provisions working in tandem. Under IRC §106, employer contributions to an HRA are excluded from the employee’s gross income entirely — the employee pays no federal income tax, no Social Security tax, and no Medicare tax on the reimbursements. Under IRC §105(b), reimbursements paid to the employee for qualified medical expenses under IRC §213(d) are also excluded from gross income. The employer, meanwhile, deducts the reimbursements as an ordinary and necessary business expense under IRC §162.
This combination creates a triple tax advantage: the employer gets a deduction, the employee pays no income tax, and neither party pays payroll taxes on the reimbursement. Compare this to the alternative where an employee pays health insurance premiums with after-tax dollars: a W-2 employee in the 22% bracket paying $600/month in premiums is spending $600 of after-tax income, which required earning approximately $769 in gross income. The HRA converts that same $600 into a fully deductible business expense with zero tax cost to the employee.
Prior to 2017, stand-alone HRAs for individual health insurance premiums were prohibited under ACA rules, which created significant confusion and compliance risk. The 21st Century Cures Act of 2016 created the Qualified Small Employer HRA (QSEHRA) as the first compliant vehicle for small employers to reimburse individual premiums. Then, in 2019, the Trump administration issued final regulations creating the Individual Coverage HRA (ICHRA), effective January 1, 2020, which removed the employer size restrictions and the annual dollar limits that constrained the QSEHRA. As of 2026, employers of any size can use an ICHRA to reimburse employees for individual health insurance premiums and qualified medical expenses without limit.
ICHRA vs. QSEHRA: Choosing the Right Vehicle for Your Client
The two primary HRA vehicles available to small business clients in 2026 are the ICHRA and the QSEHRA. Each has distinct eligibility rules, contribution limits, and compliance requirements. Choosing the wrong vehicle is one of the most common practitioner errors in this area.
Individual Coverage HRA (ICHRA): Available to employers of any size, including those with 50 or more full-time equivalent employees (who are subject to the ACA employer mandate). The ICHRA has no annual contribution limit — the employer sets the reimbursement amount. Employees must be enrolled in individual health insurance coverage (purchased through the ACA marketplace, directly from an insurer, or through Medicare) to receive ICHRA reimbursements. The ICHRA allows employers to offer different reimbursement amounts to different classes of employees (full-time vs. part-time, salaried vs. hourly, by geographic location, etc.) as long as the classes are defined under the final regulations. Employees who receive an ICHRA offer that meets the affordability standard are not eligible for the ACA premium tax credit, which is a critical planning consideration for lower-income employees.
Qualified Small Employer HRA (QSEHRA): Available only to employers with fewer than 50 full-time equivalent employees who do not offer a group health plan to any employee. The QSEHRA has annual contribution limits indexed for inflation. For 2026, the maximum QSEHRA reimbursement is $7,050 for self-only coverage and $14,100 for family coverage (per Rev. Proc. 2025-32). Employees must have minimum essential coverage (MEC) to receive QSEHRA reimbursements. Unlike the ICHRA, the QSEHRA cannot vary reimbursement amounts by employee class — all eligible employees must receive the same amount (or proportionally the same for family vs. self-only). The QSEHRA must be reported on Form W-2 Box 12 using Code FF.
| Feature | ICHRA | QSEHRA |
|---|---|---|
| Employer size | Any size | Fewer than 50 FTEs only |
| Annual limit (2026) | No limit | $7,050 self-only / $14,100 family |
| Group health plan allowed | Yes (different classes) | No |
| Employee classes | Yes (11 defined classes) | No — uniform benefit |
| ACA premium tax credit | May disqualify if affordable | Reduces credit dollar-for-dollar |
| W-2 reporting | Not required | Required (Box 12, Code FF) |
| Medicare premiums | Reimbursable | Reimbursable |
The S-Corporation Owner Problem: Why the Standard HRA Rules Don’t Apply
The most important and most frequently misunderstood aspect of HRA planning involves S-corporation owners. Under IRC §1372, a shareholder who owns more than 2% of an S-corporation is treated as a partner in a partnership for purposes of fringe benefit rules. This means that the normal exclusion under IRC §106 does not apply to 2%-or-more S-corp shareholders. An S-corp cannot simply set up an ICHRA and exclude the reimbursements from the shareholder-employee’s income.
The correct treatment for S-corp owner health insurance, established under IRS Notice 2008-1, is as follows: the S-corporation pays or reimburses the health insurance premiums for the 2% shareholder-employee. The reimbursement is included in the shareholder-employee’s W-2 wages in Box 1 (subject to income tax) but is excluded from Social Security and Medicare wages (Box 3 and Box 5). The shareholder-employee then deducts the premium as a self-employed health insurance deduction under IRC §162(l) on Schedule 1 of Form 1040, which reduces adjusted gross income without requiring itemization. The net result is that the premium is deductible at the individual level, but it does not escape payroll taxes the way a true employer-provided benefit would.
This is a critical distinction: a C-corporation can provide health insurance to its owner-employees through an ICHRA or group plan with full exclusion from all taxes (income and payroll). An S-corporation owner gets income tax deductibility but not payroll tax exclusion. For high-income S-corp owners paying $2,000/month in premiums, the payroll tax cost on that $24,000 is $3,672 in FICA (15.3% on the first $184,500 of wages, per SSA 2026 wage base). This is one of the planning considerations that sometimes makes a C-corporation structure more advantageous for owner-employees with high health insurance costs.
Step-by-Step ICHRA Implementation for a Small Business
- 1Adopt a written ICHRA plan document. The ICHRA must be established under a written plan document before the plan year begins. The document must specify the benefit classes, reimbursement amounts for each class, and the types of expenses that are reimbursable. There is no IRS-prescribed form, but the document must satisfy the requirements of the final regulations (26 CFR §54.9802-4). Off-the-shelf ICHRA plan documents are available from HRA administration platforms (PeopleKeep, Take Command Health, Thatch, etc.) for $20–$50/month.
- 2Provide 90-day advance notice to employees. The employer must provide written notice to eligible employees at least 90 days before the start of the plan year (or, for new employees, on the date they become eligible). The notice must describe the benefit, the amount available, the requirement to maintain individual coverage, and the effect on ACA premium tax credit eligibility.
- 3Employees enroll in qualifying individual coverage. Each employee must enroll in individual health insurance coverage (ACA marketplace, off-exchange, or Medicare) before submitting reimbursement requests. The employee must provide proof of coverage to the employer before reimbursement is made.
- 4Employees submit reimbursement requests with substantiation. Employees submit premium invoices or receipts for qualifying medical expenses. The employer reviews and approves the requests. Reimbursements can be made by check, direct deposit, or employer-funded debit card. The employer must maintain records of all reimbursements.
- 5Employer deducts reimbursements as a business expense. Approved reimbursements are deducted by the employer as an ordinary and necessary business expense under IRC §162. The reimbursements are not subject to payroll taxes and are not reported on the employee’s W-2 (for ICHRA; QSEHRA requires Box 12 Code FF reporting).
- 6File Form 720 if applicable. Employers with ICHRAs are subject to the Patient-Centered Outcomes Research Institute (PCORI) fee under IRC §4376, reported on Form 720. The fee for plan years ending in 2025 is $3.22 per covered life (indexed annually). This is a minor compliance item but should not be overlooked.
Worked Dollar Example: ICHRA vs. No Health Benefit
Client profile: LLC taxed as S-corporation, owner plus 3 W-2 employees. Each employee pays $600/month ($7,200/year) for individual ACA marketplace coverage. Owner pays $1,200/month ($14,400/year). Business is in the 24% federal bracket. Employees average 22% federal bracket.
Without ICHRA:
Employees pay premiums with after-tax dollars. No employer deduction. No payroll tax savings.
Employee tax cost on $7,200 premium: $7,200 × 22% income tax = $1,584 + $7,200 × 7.65% FICA = $551 = $2,135 per employee in annual taxes on health premiums.
Total tax burden on 3 employees: $2,135 × 3 = $6,405/year
With ICHRA (employer reimburses $7,200/employee + $14,400 for owner-employee):
Employer deduction: ($7,200 × 3) + $14,400 = $36,000 × 24% = $8,640 in federal tax savings for the business
Employee payroll tax savings: $7,200 × 7.65% × 3 employees = $1,652 (employer FICA also saved)
Employee income tax savings: $7,200 × 22% × 3 = $4,752
Total combined tax savings: $8,640 + $1,652 + $4,752 = $15,044/year
Note: S-corp owner’s $14,400 is included in W-2 wages and deducted on Schedule 1 under IRC §162(l) — income tax deductible but not FICA-exempt.
Frequently Asked Questions
No — a sole proprietor cannot use an ICHRA to reimburse their own health insurance premiums because an ICHRA is an employer-provided benefit and a sole proprietor cannot be their own employee for this purpose. The sole proprietor deducts health insurance premiums directly on Schedule 1 of Form 1040 under IRC §162(l), which allows a 100% deduction for health insurance premiums paid for the taxpayer, their spouse, and dependents, as long as the taxpayer is not eligible to participate in an employer-sponsored health plan. This deduction reduces AGI and is available regardless of whether the sole proprietor itemizes deductions. The ICHRA is relevant for sole proprietors who have W-2 employees — they can offer an ICHRA to those employees and deduct the reimbursements as a business expense, but cannot include themselves in the plan.
A single-employee S-corp where the sole employee is the 2%-or-more shareholder cannot use an ICHRA to achieve the same tax result as a C-corp owner because of the IRC §1372 rule discussed above. The S-corp can reimburse the shareholder-employee for health insurance premiums, but those reimbursements must be included in the shareholder-employee’s W-2 wages (Box 1 only, not Box 3/5). The shareholder-employee then claims the IRC §162(l) self-employed health insurance deduction on their personal return. This achieves income tax deductibility but not payroll tax exclusion. If the S-corp has non-owner W-2 employees in addition to the owner, the ICHRA can be structured to cover those employees with full tax exclusion, while the owner follows the Notice 2008-1 rules separately. The planning opportunity is to ensure the owner’s premiums are properly run through the S-corp payroll and reported correctly, rather than paid personally with no deduction at all — which is the most common error.
It depends on whether the ICHRA offer is “affordable” under ACA rules. An ICHRA offer is considered affordable if the employee’s required contribution for self-only coverage (the lowest-cost silver plan premium minus the ICHRA reimbursement amount) does not exceed a specified percentage of the employee’s household income. For 2026, the affordability percentage is 9.02% of household income (indexed annually). If the ICHRA offer is affordable, the employee is not eligible for the premium tax credit for any month they are eligible for the ICHRA. If the ICHRA offer is not affordable, the employee can opt out of the ICHRA and claim the premium tax credit instead. This is a critical planning point for employers with lower-wage employees who currently receive premium tax credits. Offering an ICHRA that is technically affordable could eliminate their premium tax credit and leave them worse off. Practitioners should model the affordability calculation for each employee class before recommending an ICHRA.
An ICHRA can reimburse any “medical care” expense as defined under IRC §213(d), which includes a broad range of expenses beyond insurance premiums. This includes: prescription drugs, over-the-counter medications (including menstrual care products, per the CARES Act of 2020), dental and vision care, mental health treatment, chiropractic care, acupuncture, hearing aids, LASIK surgery, long-term care insurance premiums (subject to age-based limits), and many other qualifying expenses. The IRS Publication 502 provides the most comprehensive list of qualifying medical expenses. Cosmetic procedures that are not medically necessary (teeth whitening, elective plastic surgery) do not qualify. Gym memberships and general wellness expenses generally do not qualify unless prescribed by a physician for a specific medical condition. The employer can choose to limit the ICHRA to insurance premiums only, or expand it to cover the full range of §213(d) expenses — this is a plan design decision that should be documented in the plan document.
Yes — this is one of the key advantages of the ICHRA over the QSEHRA. Under the final ICHRA regulations, an employer can offer a group health plan to one class of employees (for example, full-time salaried employees) and an ICHRA to a different class (for example, part-time employees or employees in a different geographic location). The regulations define 11 permissible employee classes: full-time employees, part-time employees, employees paid on a salaried basis, employees paid on a non-salaried basis (hourly), employees who have not satisfied a waiting period, former employees, employees in the same geographic location (rating area), seasonal employees, employees covered by a collective bargaining agreement, employees who have not attained age 25, and non-resident aliens with no U.S.-source income. The employer cannot offer an ICHRA to a class and a group health plan to the same class. The minimum class size rules also apply: if the employer has 100 or more employees, the minimum class size for certain classes (full-time, part-time, salaried, hourly) is 10 employees.
Unlike a Health FSA, an ICHRA does not have a “use it or lose it” rule in the traditional sense because the ICHRA is funded by the employer on a reimbursement basis — there is no pre-funded account that the employee “loses.” The employer simply does not reimburse expenses that were not submitted. The employer can choose to allow carryover of unused ICHRA amounts from one plan year to the next, or can design the plan to expire unused amounts at year-end. This is a plan design decision. From a tax perspective, the employer only deducts actual reimbursements made — there is no deduction for amounts that were offered but not claimed. This means the employer’s actual tax deduction may be less than the stated ICHRA benefit amount if employees do not fully utilize the benefit. Practitioners should advise clients to track actual utilization rates when projecting the tax benefit of an ICHRA.
More Tax Planning FAQs
Ready to Reduce Your Tax Burden?
Our tax advisors specialize in helping professionals and business owners implement these strategies. Book a free strategy call to see how much you could save.
Book A Strategy Call With A Tax Advisor