IRC 105 Tax Treatment Accident Health – IRC Section 105 of the Internal Revenue Code governs the tax treatment of amounts received under accident or health plans. It determines whether benefits paid to employees for personal injuries or sickness are taxable or excludable from gross income.
For US businesses, proper application of IRC Section 105 allows tax-free reimbursements for medical expenses, helping employers provide competitive benefits while reducing payroll taxes and employee tax liability. This section works alongside IRC Section 106 (which excludes employer contributions to accident and health plans from employee income) to create powerful tax advantages for qualified plans, including Health Reimbursement Arrangements (HRAs) and self-insured medical reimbursement plans.
As of 2026, these rules remain stable with no major legislative changes affecting core tax treatment, making IRC 105 a reliable tool for tax planning.
Core Rules of IRC Section 105(a): When Benefits Are Included in Gross Income
Under IRC Section 105(a), amounts received by an employee through accident or health insurance for personal injuries or sickness are generally included in gross income to the extent they are:
- Attributable to employer contributions that were not included in the employee’s gross income, or
- Paid directly by the employer.
This default inclusion rule ensures that employer-funded benefits are scrutinized for tax purposes. However, significant exceptions under subsections (b) and (c) allow most legitimate medical reimbursements to remain tax-free when properly structured.
Tax-Free Reimbursements Under IRC Section 105(b): The Primary Exclusion
The most important provision for US employers and employees is IRC Section 105(b). It excludes from gross income any amounts paid (directly or indirectly) to reimburse the taxpayer for medical care expenses (as defined in IRC Section 213(d)) incurred by the employee, spouse, dependents (as defined under Section 152), or children under age 27 at year-end.
Key requirements for tax-free treatment:
- Reimbursements must be for substantiated medical expenses.
- They cannot exceed actual expenses incurred (no “use-it-or-lose-it” cash payouts unrelated to expenses).
- Prior-year medical expense deductions under Section 213 cannot create double benefits.
This exclusion applies to both insured plans and self-insured arrangements, including reimbursements for health insurance premiums in many cases (such as in QSEHRAs). According to IRS Publication 15-B (2026), employer contributions to these plans and resulting reimbursements are generally excludable from wages for income tax, Social Security, Medicare, and FUTA purposes.
Special Exclusions Under IRC Section 105(c) for Certain Disability Payments
IRC Section 105(c) provides an additional exclusion for payments unrelated to absence from work. These include amounts for the permanent loss or loss of use of a body member or function, or permanent disfigurement of the taxpayer, spouse, or dependent. The payments must be computed based on the nature of the injury, not the time away from work.
This provision offers tax relief for accident-related lump-sum benefits that compensate for long-term impairment rather than lost wages.
How Employer Contributions Under IRC Section 106 Interact with Section 105?
While Section 105 addresses the tax treatment of benefits received, IRC Section 106 excludes employer contributions to accident or health plans from the employee’s gross income entirely. This creates a double layer of tax benefits:
- Employer contributions are not taxable to the employee.
- Qualifying reimbursements or benefits paid out are excluded under Section 105(b).
Employers receive a business expense deduction for contributions, making these plans highly efficient for both parties.
IRC Section 105(h): Nondiscrimination Rules for Self-Insured Medical Reimbursement Plans
Self-insured medical reimbursement plans (including many HRAs) must comply with strict nondiscrimination rules under IRC Section 105(h) to preserve tax-free status for highly compensated individuals.
A plan fails if it discriminates in favor of highly compensated individuals (HCIs) regarding:
- Eligibility — Must benefit at least 70% of all employees (or 80% of eligible employees if 70% are eligible), or use a nondiscriminatory classification approved by the IRS.
- Benefits — All benefits available to HCIs must be available to all other participants on the same basis.
Excludable employee categories for eligibility testing include those with less than 3 years of service, under age 25, part-time/seasonal, union employees (if bargained), and certain nonresident aliens.
Who Are Highly Compensated Individuals Under Section 105(h)?
Highly compensated individuals include:
- One of the 5 highest-paid officers.
- Shareholders owning more than 10% of the employer’s stock (with attribution rules).
- Employees among the highest-paid 25% of all participants.
If the plan is discriminatory, “excess reimbursements” to HCIs become taxable income. The excess is calculated based on whether the discrimination is in benefits or overall coverage. Non-HCIs can still exclude their benefits even if the plan fails testing.
Qualified Small Employer HRAs (QSEHRAs) and Other Section 105 Plans in 2026
QSEHRAs are a popular employer-funded Section 105 arrangement for small employers (under 50 full-time employees) that do not offer group health plans. They allow tax-free reimbursement of medical expenses and individual health insurance premiums when employees have minimum essential coverage.
2026 limits:
- $6,450 for self-only coverage.
- $13,100 for family coverage.
These are reported on Form W-2 (Code FF) but remain excludable from income. Larger employers may use Individual Coverage HRAs (ICHRAs) or traditional group health plans integrated with Section 105 rules.
Compliance, Reporting, and Best Practices for US Businesses
To maintain IRC Section 105 tax advantages:
- Maintain a written plan document.
- Substantiate all reimbursements with third-party proof.
- Conduct annual nondiscrimination testing for self-insured plans.
- Report taxable excess amounts on Form W-2 (Box 1) if applicable.
IRS Publication 15-B (2026) provides detailed employer guidance on excluding these benefits from wages. Employers should consult a tax professional to ensure compliance, especially when designing plans for small businesses or family-owned companies.
Why Proper IRC 105 Tax Treatment Matters for USA Employers and Employees in 2026?
Correct use of IRC Section 105 delivers:
- Tax-free medical reimbursements for employees.
- Deductible business expenses for employers.
- Payroll tax savings on excluded benefits.
- Flexible benefit design without the complexity of full group insurance in some cases.
With rising healthcare costs, Section 105 plans (including HRAs and QSEHRAs) remain one of the most effective tools for US businesses to attract and retain talent while optimizing taxes.
Conclusion: Navigating IRC 105 Tax Treatment Successfully
IRC Section 105 continues to provide clear pathways for tax-advantaged accident and health benefits in 2026. By understanding the inclusion/exclusion rules, nondiscrimination requirements, and available plan designs, US employers can deliver valuable benefits that are truly tax-free for employees.
For the latest official guidance, refer directly to IRS Publication 15-B and the Internal Revenue Code. Always work with a qualified tax advisor or benefits specialist to tailor plans to your specific business needs and ensure full compliance. Proper structuring under IRC Section 105 can deliver significant tax savings while supporting employee wellness.