Section 105 HRA: The Tax Tool Nonprofits Overlook
Your benefits budget is under pressure, your margins are thin, and your broker just handed you a renewal with a 12% rate increase. Meanwhile, a cost-control tool has been sitting in the tax code for decades, available to any employer, including yours, with no minimum workforce size. Most nonprofits have never used it correctly. That gap isn't abstract. It shows up in payroll taxes you didn't need to pay, reimbursements that became taxable income because one compliance box got missed, and turnover that a better benefits structure might have slowed.
In This Post
- What is a Section 105 health reimbursement arrangement and who can use it?
- Designing a compliant plan: Nondiscrimination, eligibility, and documentation
- IRS audit triggers, documentation failures, and tax exposure
- What works for Southeast nonprofits and senior care facilities
- What most nonprofits miss about Section 105 HRAs
- Work with a benefits advisor who understands your sector
- Frequently asked questions
Key Takeaways
| Tax-free by design | A Section 105 HRA lets any employer, including nonprofits, reimburse qualified medical expenses without those dollars counting as wages, but only when the plan is designed and documented correctly from the start. |
| Nondiscrimination is where plans fail | Failing the IRC Section 105(h) eligibility or benefits test doesn't just void your tax advantage. It converts those reimbursements into fully taxable income for your highest-paid employees, plus payroll tax exposure on top. |
| ICHRA or QSEHRA may fit better | For nonprofits with variable or part-time staffing, a traditional Section 105 plan may not match how your workforce actually looks. Alternative structures deserve a direct comparison before you commit to one. |
| Annual attention determines real value | The organizations getting the most out of their HRA aren't the ones who built it carefully at launch. They're the ones running compliance reviews, adjusting benefit amounts, and communicating the benefit every year after that. |
What Is a Section 105 Health Reimbursement Arrangement and Who Can Use It?
A Section 105 HRA is an employer-funded plan that reimburses employees for out-of-pocket medical expenses, and those reimbursements don't count as taxable wages. You set the benefit amount. Your employee submits documented expenses. The money flows back to them tax-free.
Simple in concept. Only valuable when the mechanics are right.
The IRS defines eligible expenses broadly under IRC Section 213(d): insurance premiums, deductibles, copays, dental, vision, prescription drugs, mental health services, and long-term care costs. That last category is worth noting if you run a senior care facility. Reimbursements must cover expenses already incurred, backed by receipts or Explanations of Benefits, and paid directly to the employee.
Nonprofits, including 501(c)(3) organizations, qualify. No workforce minimum. No sector-specific exemptions. The structure is built for organizations that want cost control and flexibility without the overhead of a traditional group plan, which is exactly the position most mission-driven employers are in.
Here is how Section 105 compares to other common HRA structures:
| Section 105 HRA | Any employer, including nonprofits | Yes, with group plan | Must pair with group coverage |
| ICHRA | Any employer | Yes | Employees must have individual coverage |
| QSEHRA | Small employers only (under 50 FTEs) | Yes | Employees must have minimum coverage |
| EBHRA | Any employer | No | Supplements existing group coverage |
For a nonprofit benefits strategy, Section 105 frequently wins on flexibility and cost control, provided the plan design holds up to IRS scrutiny. The most impactful eligible expense categories include:
- Insurance premiums (medical, dental, vision)
- Prescription drug costs
- Mental health and behavioral therapy
- Chiropractic and physical therapy
- Long-term care services (especially relevant for senior care staff)
- Medical equipment and supplies
Designing a Compliant Health Reimbursement Plan: Nondiscrimination, Eligibility, and Documentation
Most organizations don't stumble on the rules because they're obscure. They stumble because the rules require ongoing attention, and that attention tends to disappear after launch.
Under IRC Section 105(h), your plan must pass two tests every year. The Eligibility Test requires that at least 70% of your non-highly compensated employees benefit from the plan. The Benefits Test requires that your highest-paid people receive benefits on the same terms as everyone else. Fail either one, and the excess reimbursements paid to your highly compensated employees become ordinary taxable income. That outcome is predictable. It is also avoidable, but only if the plan is built correctly from the start.
A working compliance checklist:
- Define plan eligibility clearly in writing before the plan year begins
- Identify all highly compensated individuals on your payroll
- Run nondiscrimination testing annually, not just at plan launch
- Collect and retain substantiation receipts for every reimbursement
- Establish a formal claims and appeals procedure
- Distribute a Summary Plan Description to all eligible employees
- Coordinate with your benefits compliance team to track annual filing requirements
Documentation is your primary defense in an audit. Here is a working record-keeping structure:
| Reimbursement requests | HR or plan administrator | 6 years minimum |
| Receipts and EOBs | HR or plan administrator | 6 years minimum |
| Nondiscrimination test results | HR or finance | 6 years minimum |
| SPD and plan documents | HR | Duration of plan plus 6 years |
| Employee eligibility records | HR | Duration of employment plus 6 years |
One practical note: run a mock nondiscrimination test mid-year, not just at year-end. Catching an eligibility gap in July gives you time to fix it. Finding it in December gives you a tax problem.
IRS Audit Triggers, Documentation Failures, and Tax Exposure
Knowing the rules is one thing. Knowing what happens when they break down is what most plan sponsors miss.
The most common audit triggers aren't exotic. IRS scrutiny typically follows documentation gaps, spousal employment arrangements handled incorrectly, or nondiscrimination testing that was run once and then forgotten. When any of these fail, your previously tax-free reimbursements become fully taxable income for your highest-paid employees. Add payroll tax exposure and potential penalties on top of the original benefit cost. The plan designed to save money now costs more than the traditional benefit would have.
The most common pitfalls in nonprofit and senior care settings:
- Reimbursing a spouse's medical expenses without verifying the spouse is a legitimate plan participant
- Submitting claims after the plan year deadline
- Offering different benefit amounts to different employee classes without a documented rationale
- Failing to update plan documents when your staffing structure changes
- Treating the HRA as a standalone benefit rather than integrating it into a broader benefits strategy
The consequences are concrete. If your executive director received $4,000 in HRA reimbursements during a year your organization fails the Benefits Test, that $4,000 becomes ordinary income. Your organization owes payroll taxes. The employee owes income taxes. Congratulations, you've now paid more than a traditional benefit would have cost you.
Alternatives like ICHRA and QSEHRA carry their own ACA compliance requirements and coverage restrictions. Review those tradeoffs against your actual staffing model before choosing a structure, not the one that looked clean on paper at plan launch.
One practical step: keep a dedicated compliance folder with dated copies of all plan documents, test results, and reimbursement records. If an IRS examiner asks for documentation, you want to hand over a complete file in under ten minutes.
What Works for Southeast Nonprofits and Senior Care Facilities
Senior housing runs lean. Expense ratios in senior housing fall between 50% to 70% of revenue, which means every dollar recovered through smarter benefits design lands directly on operational sustainability. That's not a rounding error.
Southeast nonprofits and senior care facilities share a specific set of pressures: a volatile labor market, high turnover in direct care roles, and limited HR capacity. Benefits design matters more here than in most environments. It is also harder to execute well. ERISA and Section 105(h) rules apply uniformly across the region. There's no geographic shortcut, but the staffing reality on the ground varies significantly.
For organizations with highly variable headcount, assisted living facilities that depend on part-time and PRN workers for example, an ICHRA (an arrangement where employees buy their own individual coverage and you reimburse them) may fit better than a traditional Section 105 HRA tied to a group plan. When your workforce fluctuates month to month, a structure that requires group coverage as a baseline can work against you. The right answer depends on your actual staffing model, not a generic recommendation.
Three implementation approaches that work well in this environment:
- Onboarding integration: Introduce the HRA during new hire orientation, not as a buried line item in the benefits packet. Employees who understand their healthcare reimbursement account from day one use it more effectively and value it more as a retention signal.
- Plain-language communication: Provide a one-page explainer alongside the formal Summary Plan Description. Many direct care workers aren't accustomed to navigating benefits documents. Clarity at the outset increases participation, which is the whole point.
- Administrative automation: Benefits platforms that automate claim submission and receipt tracking reduce administrative burden and audit risk at the same time. That's a real advantage for HR teams managing high staff volume with limited capacity.
What Most Nonprofits Miss About Section 105 HRAs
Most organizations launch a Section 105 HRA, check the box, and move on. They treat it like a fixed line item instead of a living component of their benefits strategy. That's exactly where the value disappears.
HRAs work best when they're embedded in a broader HR strategy. Organizations that have paired an HRA redesign with a focused staff communication effort have seen meaningful improvements in both participation rates and perceived compensation value. Employees who understand what the benefit covers and how to submit a claim actually use it. Usage converts into retention value, and in a sector where salary competition is unwinnable for most mission-driven employers, that matters more than almost anything else in the benefits package.
A 2011 structural equation modeling study of 1,228 employees found that the number of distinct benefit programs an employer offers has its own measurable retention effect, independent of job satisfaction itself. It's not just whether the benefits are good. It's whether employees can see that you've thought carefully about what they need. An HRA that nobody understands, uses, or hears about annually isn't signaling that. It's signaling the opposite.
The organizations extracting the most value from Section 105 are running annual compliance reviews, adjusting benefit amounts to reflect what employees actually spend, and treating the HRA as a deliberate signal that leadership invests in their people. That posture requires ongoing effort. It also produces results that a set-and-forget plan never will.
Work With a Benefits Advisor Who Understands Your Sector
A Section 105 HRA offers real, measurable savings for mission-driven organizations. The gap between a plan that works and one that creates unexpected tax liability is almost always a process problem, not an intention problem. Thrive Benefits Group works with nonprofits and senior care facilities across the Southeast to build benefits structures that reduce costs without reducing value to employees. Schedule a conversation to talk through your specific situation.
Frequently Asked Questions
Which expenses can be reimbursed under a Section 105 HRA?
Section 105 HRAs can reimburse IRS-qualified medical expenses as defined under IRC Section 213(d), including premiums, deductibles, copays, dental, vision, prescription drugs, and long-term care costs.
Are Section 105 HRAs available to nonprofits and senior care facilities?
Yes. Both nonprofits and senior care facilities can sponsor Section 105 HRAs. 501(c)(3) organizations must meet the same plan design and nondiscrimination compliance requirements as any other employer. There are no sector-specific exemptions.
What documentation is required to maintain Section 105 HRA compliance?
Employers must retain records of eligible expenses, reimbursement requests, and substantiated receipts for all claims, typically for a minimum of six years. Plan documents, nondiscrimination test results, and employee eligibility records require the same retention standard.
What are the main risks in offering a Section 105 HRA?
The primary risks are IRS audit failure, improper documentation, and nondiscrimination testing failures. Any of these can convert tax-free reimbursements into taxable income for highly compensated employees, generating payroll tax exposure and potential penalties.
How does a Section 105 HRA differ from an ICHRA or QSEHRA?
A Section 105 HRA must pair with group coverage, while an ICHRA allows reimbursement of individual market premiums and a QSEHRA is limited to employers with fewer than 50 full-time employees. The right structure depends on your headcount, staffing model, and how your workforce accesses coverage.
