Section 105 HRAs: Cut Nonprofit Benefit Costs with Confidence
- Sydney Little
- 6 days ago
- 8 min read
Your benefits budget is under pressure, your margins are thin, and your broker just renewed the same group plan with a 12% rate increase. Meanwhile, a structural cost-control tool has been sitting in the tax code for decades — fully available to organizations your size, fully applicable to your workforce — and most nonprofits have never used it correctly. The cost of that gap isn't abstract. It shows up in payroll taxes you didn't need to pay, reimbursements that became taxable income because a compliance box got missed, and turnover that a better benefits structure might have slowed.
In This Post
Key Takeaways
Tax-free by design | A Section 105 HRA lets any employer, including nonprofits, reimburse qualified medical expenses tax-free — but only when the plan is designed and documented correctly. |
Nondiscrimination is the failure point | IRS rules under IRC Section 105(h) are where most plans break down, and a failed test converts tax-free reimbursements into fully taxable income. |
ICHRA or QSEHRA may fit better | For nonprofits with variable staffing, a traditional Section 105 plan may not match operational reality — alternative structures deserve a direct comparison. |
Annual reviews determine real value | HRAs work best as a living part of a broader benefits strategy; the organizations extracting the most value are adjusting and communicating the benefit year over year. |
What Is a Section 105 Health Reimbursement Arrangement — and Who Can Use It?
A section 105 health reimbursement arrangement is an employer-funded plan that reimburses employees for out-of-pocket medical expenses without those reimbursements counting as taxable wages. The employer sets the benefit amount. Employees submit documented expenses. The reimbursement flows tax-free. Simple in concept — but only valuable when the underlying mechanics are correct.
The IRS defines eligible expenses broadly under IRC Section 213(d). Qualified health expenses include insurance premiums, deductibles, copays, dental, vision, prescription drugs, mental health services, and long-term care costs — a category particularly relevant for staff at senior care facilities. Reimbursements must be tied to expenses already incurred, substantiated by receipts or Explanations of Benefits, and paid directly to the employee.
Nonprofits, including 501(c)(3) organizations, can offer IRS Section 105 benefits as self-insured plans. There are no nonprofit-specific exemptions and no minimum workforce size requirement. The structure suits organizations that want cost-effective, flexible benefits without the administrative overhead of traditional group insurance.
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, the Section 105 HRA 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
Compliance is where most organizations stumble — not because the rules are obscure, but because they require ongoing attention that plan sponsors often deprioritize after launch.
Under IRC Section 105(h), self-insured HRAs must pass two annual tests. The Eligibility Test requires that at least 70% of non-highly compensated employees benefit from the plan. The Benefits Test requires that highly compensated individuals receive benefits on the same terms as everyone else. Fail either test, and excess reimbursements paid to highly compensated employees become taxable income. That outcome is predictable and avoidable — but only if the plan is structured correctly from the start.
A working compliance checklist looks like this:
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 |
For organizations exploring the tax advantages of HRAs, this documentation framework is the foundation everything else rests on. It also directly supports open enrollment — employees who receive clear, timely documentation of what they need to submit are more likely to use the benefit correctly.
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 correct it before it becomes a tax liability in December.
IRS Audit Triggers, Documentation Failures, and Tax Exposure
Understanding the rules is one thing. Understanding what happens when they break down is another.
The most common audit triggers for a Section 105 HRA are not exotic — they are preventable. IRS scrutiny typically follows documentation gaps, spousal employment arrangements handled incorrectly, or nondiscrimination testing that was run once and then ignored. When any of these fail, previously tax-free reimbursements become fully taxable income for your highest-paid employees, generating payroll tax exposure and potential penalties on top of the original benefit cost.
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 (late substantiation)
Offering different benefit amounts to different employee classes without a documented rationale
Failing to update plan documents when staffing structures change
Treating the HRA as a standalone benefit rather than integrating it into a broader benefits strategy
The tax consequences are concrete. If your executive director received $4,000 in HRA reimbursements during a plan year where your organization fails the Benefits Test, that $4,000 becomes ordinary income. Your organization owes payroll taxes. The employee owes income taxes. The plan designed to reduce costs now costs more than a traditional benefit would have.
Alternatives like ICHRA or 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 is an expensive operation. Expense ratios in senior housing run between 50% and 70% of revenue, which means every dollar recaptured through smarter benefits design has a direct impact on operational sustainability.
Southeast nonprofits and senior care facilities face a specific set of pressures: a volatile labor market, high turnover in direct care roles, and limited HR infrastructure. These factors make benefits design more important and harder to execute well at the same time. ERISA and Section 105(h) rules apply uniformly across the region — there is no geographic shortcut. What does differ is the staffing reality on the ground.
For organizations with highly variable headcount — assisted living facilities that rely on part-time and PRN workers, for example — an ICHRA may be a better structural fit than a traditional Section 105 HRA. ICHRA allows employees to purchase individual coverage and receive reimbursement, which works well when your workforce fluctuates month to month. 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 are not accustomed to navigating benefits documents, and clarity at the outset increases participation.
Administrative automation: Benefits platforms that automate claim submission and receipt tracking reduce administrative burden and audit risk simultaneously — 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, breathe a sigh of relief, and stop paying attention. They treat it as a fixed line item rather than a living component of their benefits strategy. That is where real value gets left behind.
HRAs work best when embedded in a broader HR strategy — not siloed as a standalone cost-control mechanism. 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 access it actually use it, and usage translates into retention value in a sector where salary competition is unwinnable for most mission-driven employers.
The organizations extracting the most value from Section 105 benefits are running annual compliance reviews, adjusting benefit amounts to reflect actual employee needs, and treating the HRA as a deliberate signal to staff that leadership invests in their wellbeing. That posture requires ongoing effort — and it 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 — but the gap between a plan that works and one that creates unexpected tax liability is almost always process, not intention. 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.
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