Yes, — but a sole proprietor cannot use the plan’s tax-free benefits for themselves. Under IRC Section 105(g), the IRS treats a sole proprietor as a self-employed individual, not an employee of their own business. This one rule blocks direct participation in any Section 105 plan.
The proven workaround is to hire your spouse as a W-2 employee and offer a Section 105 Health Reimbursement Arrangement (105-HRA) as part of their compensation. The IRS sanctioned this strategy through Revenue Ruling 71-588 and confirmed it in Speltz v. Commissioner (T.C. Summary Opinion 2006-25). According to the Kaiser Family Foundation, the average annual premium for family health coverage reached $25,572 in 2025 — making a 100% tax deduction on those costs a big deal for any sole proprietor.
Here’s what you’ll learn:
- 🔍 Why IRC Section 105(g) blocks sole proprietors from direct benefits — and the one legal path around it
- 💰 How to turn 100% of family medical expenses into Schedule C business deductions that lower income tax and self-employment tax
- ⚖️ What the U.S. Tax Court ruled in Speltz v. Commissioner — and the five things the winning couple did right
- 🚫 The critical mistakes that trigger IRS audits, disallowed deductions, and potential excise tax penalties of $100 per day
- 📋 A step-by-step breakdown of setting up a compliant 105-HRA, including plan documents, time sheets, and reimbursement procedures
What IRC Section 105 Actually Says About Sole Proprietors
Section 105 of the Internal Revenue Code governs the tax treatment of amounts received under employer-provided accident and health plans. It allows employees to exclude from gross income any reimbursements their employer pays for medical care expenses under Section 213(d). The key word here is “employee.”
Section 105(g) states that a self-employed individual is not treated as an employee for purposes of this section. A sole proprietor who files Schedule C on their Form 1040 falls into this category. The IRS does not view you as your own employee — you are the business itself.
This means a sole proprietor cannot set up a Section 105 plan and reimburse themselves for medical expenses on a tax-free basis. The reimbursement would not qualify for exclusion from gross income. It would just be money moving from one pocket to another, with zero tax benefit.
Where Revenue Ruling 71-588 Opens the Door
Revenue Ruling 71-588 is the foundational IRS guidance that makes the spouse-employee strategy possible. This 1971 ruling confirms that a sole proprietor can hire their spouse as a bona fide employee and provide health benefits under a Section 105 plan as part of the spouse’s compensation package.
The ruling establishes that the medical benefits paid from an employer-spouse to an employee-spouse are deductible by the business and excludable from the employee-spouse’s gross income. The employer (you, the sole proprietor) claims the deduction on Schedule C. The employee (your spouse) pays no income tax on the reimbursements received.
This works because the plan covers the employee and the employee’s family members. Your spouse is the employee. You, the sole proprietor, are the employee’s spouse. Your children are the employee’s dependents. The plan reimburses expenses for the entire family — and the business gets to deduct every dollar.
How a 105-HRA Turns Personal Medical Costs Into Schedule C Deductions
A Section 105 Health Reimbursement Arrangement (105-HRA) is a specific type of Section 105 plan that reimburses one employee for medical expenses. The “105-HRA” name combines its two legal foundations: the Section 105 medical reimbursement plan and the health reimbursement arrangement structure recognized in IRS Notice 2002-45.
The big picture is straightforward. The Section 105 plan converts what would be personal medical expenses — which have limited tax benefits — into business expenses that reduce both income tax and self-employment tax. Without this plan, most medical costs for a sole proprietor sit on Schedule A as itemized deductions, subject to a harsh 7.5% of adjusted gross income (AGI) floor.
The Tax Math That Makes This Powerful
Consider a sole proprietor named Lisa who earns $120,000 in net business income and spends $20,000 per year on family health insurance premiums, co-pays, dental work, and prescriptions. Lisa is in the 24% federal income tax bracket and pays 15.3% in self-employment tax.
| Without a 105-HRA | With a 105-HRA |
|---|---|
| $20,000 in medical expenses goes on Schedule A | $20,000 in medical expenses is a Schedule C deduction |
| Subject to 7.5% AGI floor — Lisa loses $9,000 of the deduction | No AGI floor — full $20,000 is deductible |
| Net deduction: ~$11,000 (after the floor) | Net deduction: $20,000 |
| Saves ~$2,640 in federal income tax only | Saves ~$4,800 in income tax plus ~$2,826 in self-employment tax |
| Total tax savings: ~$2,640 | Total tax savings: ~$7,626 |
Lisa saves nearly $5,000 more per year by using the 105-HRA. The self-employment tax savings alone make this strategy far more valuable than the standard itemized deduction route. Over 10 years, that is close to $50,000 in extra tax savings.
Why This Beats the Self-Employed Health Insurance Deduction
Many sole proprietors already know about the self-employed health insurance deduction on Schedule 1, Line 17 of Form 1040. This deduction allows self-employed individuals to deduct health insurance premiums — but it has two major limitations that the 105-HRA does not.
| Self-Employed Health Insurance Deduction | 105-HRA Deduction |
|---|---|
| Covers insurance premiums only | Covers premiums plus all out-of-pocket medical expenses |
| Reduces federal and state income tax | Reduces income tax and self-employment tax |
| Not available if you’re eligible for an employer-subsidized plan (like a spouse’s employer plan) | No such restriction for the employee-spouse |
| Deducted on Schedule 1 — does not reduce SE tax | Deducted on Schedule C — reduces SE tax |
| Cannot cover co-pays, deductibles, dental, or vision out-of-pocket | Can cover every Section 213(d) eligible expense |
The 105-HRA is the superior strategy when the sole proprietor has a spouse who performs real work for the business. If the insurance policy is placed in the employee-spouse’s name, the self-employed health insurance deduction on Schedule 1 does not even apply — making the 105-HRA the only path to deduct those premiums.
Every Expense a Section 105 Plan Can Reimburse
The 105-HRA can reimburse any medical care expense defined under IRC Section 213(d). You can find the full list in IRS Publication 502. These expenses must be for the employee, the employee’s spouse, the employee’s dependents, or any child of the employee under age 27.
Eligible expenses include but are not limited to:
- Health, dental, and vision insurance premiums
- Medicare Part A, Part B, and supplement premiums
- COBRA premiums
- Long-term care insurance premiums (subject to age-based limits)
- Prescription drugs
- Co-pays and deductibles
- Lab work, X-rays, and diagnostic tests
- Mental health and counseling services
- Chiropractic care and physical therapy
- Eyeglasses, contacts, and LASIK surgery
- Dental crowns, implants, and orthodontia
- Hearing aids
- Medical equipment (crutches, wheelchairs, blood pressure monitors)
The plan cannot reimburse expenses that occurred before the plan’s effective date or before the employee enrolled. Cosmetic surgery that is not medically necessary is also not eligible. Gym memberships and general wellness programs typically do not qualify unless a doctor prescribes them for a specific medical condition.
Setting Up a 105-HRA: Every Step, Form, and Detail
A compliant 105-HRA requires several documents, processes, and ongoing administrative practices. Cutting corners on any of these creates risk. The IRS closely scrutinizes spousal employment arrangements, and missing documentation is the number one reason these plans get disallowed.
Step 1: Create a Written Plan Document
The IRS requires a formal written plan document that establishes the 105-HRA. This document must spell out:
- The plan’s effective date
- Which employees are eligible
- What expenses the plan reimburses
- The maximum annual reimbursement amount
- How employees submit claims and get reimbursed
- Whether unused amounts carry over to future years
Both the employer-spouse (the sole proprietor) and the employee-spouse must sign and date the plan document. Revenue Ruling 2002-41 also permits a carry-over provision, which lets unused reimbursement amounts roll to future plan years. This can be valuable in years when medical expenses are low.
Step 2: Establish a Bona Fide Employment Relationship
The employee-spouse must perform real, documented work for the business. This is the most scrutinized element of any 105-HRA. The IRS applies the common law agency test — meaning you need to prove that the employer has the right to control what work the employee does, when, and how.
A written employment agreement helps, but the Bradford Tax Institute recommends focusing more on weekly time sheets rather than employment contracts. Contracts tend to become outdated fast when the actual tasks change. A time sheet that records the date, the work done, and hours spent is stronger proof in an IRS audit.
Step 3: Document Hours With Weekly Time Sheets
Your employee-spouse should submit a weekly time sheet to the business. Each entry should include the date, a brief description of the work performed, and the time spent. Mrs. Speltz’s detailed calendar notations of her husband’s work hours were a critical factor in winning the Speltz case.
Keep these time sheets for at least seven years. In the event of an audit, these records are your first line of defense. The IRS has disallowed 105 plans in cases like Haeder v. Commissioner specifically because the taxpayers failed to document the spouse’s work activities.
Step 4: Set Reasonable Compensation
The total compensation paid to your employee-spouse — whether in the form of 105-HRA reimbursements, cash wages, or a combination — must be reasonable for the work performed. The IRS can disallow the deduction if the compensation is inflated beyond what an unrelated employee would earn for similar work.
To determine reasonable compensation, divide the total annual reimbursement by the hours worked. If your spouse works 500 hours and receives $20,000 in 105-HRA reimbursements, that equals $40 per hour. Research comparable pay rates on job boards, salary guides, and industry publications. Print and save this evidence in your tax file.
Step 5: Pay Reimbursements From a Separate Business Account
Your employee-spouse should pay all medical expenses from their own personal checking account first. The spouse then submits a reimbursement request with receipts to the business. The business writes a check from its separate business checking account to the employee-spouse.
This process creates a clear paper trail that separates business and personal expenses. Never pay medical providers directly from the business account — this blurs the line and invites IRS scrutiny. The reimbursement request should be submitted at least monthly.
Step 6: Decide Whether to Issue a W-2
Here’s a detail that surprises many people: the 105-HRA reimbursement can be the sole source of compensation for your employee-spouse. If no cash wages are paid, there is no requirement to file a W-2, withhold payroll taxes, or make payroll tax payments. The reimbursements are tax-free fringe benefits — not wages.
Many tax professionals still recommend issuing a small W-2 (even $1,000 in cash wages) as added proof of employment. This is a judgment call. The W-2 creates a clear paper trail showing the IRS that an employer-employee relationship exists. The downside is that it triggers payroll tax withholding and filing requirements on that cash portion.
The Speltz v. Commissioner Ruling That Proved This Strategy Works
Speltz v. Commissioner (T.C. Summary Opinion 2006-25) is the landmark Tax Court case that validated the Section 105 spouse-employee strategy for sole proprietors. The IRS challenged everything — and lost on all counts.
The Facts of the Case
Maureen Speltz operated a sole proprietorship daycare business out of her home in Rollingstone, Minnesota. She hired her husband, Peter Speltz, on a part-time basis to help with the daycare. Peter monitored children after he returned from his full-time job, took them on outdoor activities, repaired toys, chopped firewood, shoveled snow, and maintained the property.
Mrs. Speltz set up a written accident and health plan with the help of a tax adviser in 2000. Peter’s entire compensation was in the form of Section 105 plan reimbursements — no cash wages were paid. The plan capped reimbursements at $6,500 per year. The actual deductions claimed were $3,279 in 2000 and $4,539 in 2001.
What the IRS Argued
The IRS threw four separate arguments at the Speltzes to disallow the deductions:
| IRS Argument | What the IRS Claimed |
|---|---|
| No proper plan | The Section 105 plan was not set up correctly |
| Not a real employee | Peter Speltz was not a bona fide employee of the daycare |
| Not ordinary and necessary | The reimbursements were not ordinary and necessary business expenses |
| Unreasonable compensation | The reimbursements were excessive for the work Peter performed |
What the Tax Court Decided
The Tax Court ruled in favor of the Speltzes on every issue. Judge Kroupa found that the daycare had established a proper accident and health plan, that Peter had notice and knowledge of the plan, that Peter was a bona fide employee under the common law agency test, and that the compensation was reasonable.
On the employment issue, the court noted that Mrs. Speltz had the right to control Peter’s work activities, directed which children he cared for, and had the contractual right to discharge him. Peter’s work was integral to the business, and Mrs. Speltz maintained contemporaneous notes detailing his activities.
On reasonable compensation, the math worked in the Speltzes’ favor. Peter earned approximately $6.34 per hour in 2000 and $6.50 per hour in 2001. Mrs. Speltz testified she would have had to pay a substitute $13 per hour for the same work. The court found the compensation was well within reasonable bounds.
Five Things the Speltzes Did Right
The Speltz case provides a blueprint for any sole proprietor looking to implement this strategy:
- They had a written employment agreement between the proprietor and the employee-spouse, with the employee clearly qualified to do the work
- The Section 105 plan was established in writing, and reimbursements were designated as a form of compensation
- The employee-spouse’s hours were documented with written records showing consistent weekly work
- An annual cap on reimbursements kept actual payments within reasonable compensation for the work performed
- The employee-spouse submitted adequate evidence for every medical expense that was reimbursed
Why Bona Fide Employment Is the Make-or-Break Factor
The IRS applies close scrutiny to any employer-employee relationship that involves family members. This higher standard comes from decades of case law, including Denman v. Commissioner (48 T.C. 439) and Haeder v. Commissioner (T.C. Memo. 2001-7). The Tax Court examines whether payments were made because of the work relationship — or because of the family relationship.
The Common Law Agency Test
Courts use several factors from Community for Creative Non-Violence v. Reid (490 U.S. 730) to determine whether a real employer-employee relationship exists:
- Does the employer have the right to control the employee’s work activities?
- What skills does the work require?
- Does the employer provide the tools and location for the work?
- What is the duration of the relationship?
- Can the employer assign additional tasks?
- How much discretion does the employee have over work hours?
- How is the employee paid?
- Is the work part of the regular business of the employer?
No single factor is controlling. The court looks at the totality of the circumstances. A spouse who answers phones, manages bookkeeping, handles customer emails, maintains inventory, or provides any other genuine business service can qualify as a bona fide employee.
Where the IRS Has Won — Haeder v. Commissioner
In Haeder v. Commissioner (T.C. Memo. 2001-7), a taxpayer-attorney claimed his wife was an employee of his home law practice. The court rejected the claim. The practice had few clients, required little assistance, only the attorney testified (and his testimony was “vague, generalized, and conclusory”), and no records documented the spouse’s work or hours.
The contrast with Speltz is stark. The Speltzes had detailed written records, consistent work patterns, training requirements from the State of Minnesota, and testimony from both spouses. The lesson is clear: documentation wins cases, and its absence loses them.
Nondiscrimination Rules Under Section 105(h) — When They Bite
Section 105(h) of the IRC imposes nondiscrimination rules on self-insured medical reimbursement plans. These rules say the plan cannot favor highly compensated individuals (HCIs) in eligibility or benefits. If the plan discriminates, HCIs must include the excess reimbursements in their gross income — destroying the tax benefit.
The One-Employee Exception
Here’s the good news for most sole proprietors using the spouse-employee strategy: if your business has only one employee (your spouse), the nondiscrimination rules are far less of a concern. IRS Notice 2013-54 confirms that the Affordable Care Act’s market reform rules do not apply to a business that has only one employee.
This means a 105-HRA with a single employee-spouse avoids the ACA penalties that would otherwise apply to standalone HRAs offered to multiple employees. The plan can reimburse individual health insurance premiums and out-of-pocket medical expenses without triggering the $100-per-day excise tax under IRC Section 4980D.
When You Have Other Employees
If your sole proprietorship has any other employees besides your spouse, the rules change dramatically. The plan must comply with the Section 105(h) nondiscrimination requirements, and you must also consider ACA market reform compliance. A standalone HRA that reimburses individual insurance premiums for multiple employees can trigger the $100-per-day, per-employee excise tax — which adds up to $36,500 per employee per year.
The plan can exclude certain employees under Regulation Section 1.105-11:
- Employees who have not completed three years of service
- Employees under age 25
- Part-time and seasonal employees
Be careful with these exclusions. If your spouse is a part-time employee working 18 hours a week, do not set a plan rule that excludes employees working fewer than 25 hours. You would exclude your own spouse from the plan.
Section 105 Plan vs. QSEHRA vs. ICHRA — Which Plan Fits?
Sole proprietors with more than one eligible employee cannot use the one-person 105-HRA. Two alternatives exist: the Qualified Small Employer HRA (QSEHRA) and the Individual Coverage HRA (ICHRA). Each has different rules, caps, and eligibility requirements.
| Feature | One-Person 105-HRA | QSEHRA |
|---|---|---|
| Maximum employees | One eligible employee only | Fewer than 50 full-time equivalents |
| Annual reimbursement cap | No federal cap — must be reasonable compensation | $6,450 (self-only) / $13,100 (family) in 2026 |
| Owner participation | Sole proprietor: no. C-corp owner: yes | Sole proprietor: no |
| Can reimburse individual premiums? | Yes | Yes |
| Can reimburse out-of-pocket medical? | Yes | Yes |
| ACA excise tax risk | None (one employee = exempt) | None (QSEHRA is ACA-compliant by design) |
| Requires group health plan? | No | No |
The QSEHRA was created by the 21st Century Cures Act and is designed for small employers who do not offer group health insurance. It has strict annual caps on reimbursements, making it less powerful than the uncapped 105-HRA for a single employee.
The ICHRA (Individual Coverage HRA) has no employer size limits and no annual contribution caps, but it requires employees to enroll in individual health insurance. Sole proprietors cannot participate in an ICHRA they establish — only their W-2 employees can. The ICHRA is a strong option for sole proprietors with multiple non-spouse employees.
Three Real-World Scenarios Every Sole Proprietor Should See
Scenario 1: Marcus — Freelance Consultant With a Spouse Who Helps
Marcus runs a freelance IT consulting business as a sole proprietor. His wife, Dana, handles invoicing, client scheduling, and bookkeeping — about 15 hours per week. They spend $18,000 per year on family health insurance premiums and $4,000 on out-of-pocket medical costs.
Marcus hires Dana as his only W-2 employee and sets up a 105-HRA with a $22,000 annual cap. Dana submits monthly reimbursement requests with receipts. Marcus pays the reimbursements from his business checking account and deducts the full $22,000 on Schedule C.
| What Marcus Does | What Happens |
|---|---|
| Hires Dana as his only W-2 employee | Creates a valid employer-employee relationship |
| Sets up a written 105-HRA plan | Establishes the legal framework for tax-free reimbursements |
| Dana submits time sheets every week | Documents bona fide employment for IRS scrutiny |
| Dana pays medical bills from her personal account | Creates clean paper trail for reimbursement |
| Marcus reimburses Dana from the business account | Claims $22,000 Schedule C deduction — saves ~$8,600 in taxes |
Scenario 2: Rachel — Bakery Owner With Three Employees
Rachel owns a bakery as a sole proprietor. She employs three bakers and wants to hire her husband, Tom, to manage deliveries. Rachel cannot use a one-person 105-HRA because she has more than one eligible employee.
If Rachel offers a standalone HRA that reimburses individual premiums to Tom only, she violates the Section 105(h) nondiscrimination rules and triggers the $100-per-day excise tax for each of her other employees.
| What Rachel Does | What Happens |
|---|---|
| Sets up a 105-HRA for Tom only, ignoring other employees | Violates nondiscrimination rules — faces $100/day/employee excise tax |
| Sets up a QSEHRA for all employees including Tom | Compliant — but reimbursements are capped at $13,100 for family coverage |
| Sets up an ICHRA for all employees | Compliant and no cap — but Rachel herself still cannot participate |
Rachel’s best option is a QSEHRA or ICHRA that covers all eligible employees, including Tom.
Scenario 3: Kevin — Sole Proprietor With No Spouse
Kevin is a single, self-employed graphic designer. He has no spouse and no employees. Kevin cannot use the 105-HRA strategy because there is no one to hire as an employee.
Kevin’s options are limited to the self-employed health insurance deduction on Schedule 1 for his premiums and itemizing medical expenses on Schedule A for out-of-pocket costs. If Kevin wants the full power of a Section 105 plan, his best path is to incorporate as a C corporation. As a C-corp, Kevin becomes an employee of his own corporation and can participate in a 105-HRA directly.
| What Kevin Does | What Happens |
|---|---|
| Stays a sole proprietor, no spouse | Limited to self-employed health insurance deduction and Schedule A |
| Incorporates as a C corporation | Can participate in a 105-HRA as the sole employee of the C-corp |
Mistakes to Avoid With a Section 105 Plan
Mistake #1: No written plan document. The IRS requires a formal written plan. Without one, every reimbursement is treated as a non-deductible personal expense — and the employee must include the payments in gross income.
Mistake #2: No time sheets or work records. This killed the taxpayers in Haeder v. Commissioner. The court found their testimony “vague” and “conclusory.” No written work records means no proof of employment — and the IRS wins.
Mistake #3: Paying medical providers directly from the business account. The correct process is for the employee-spouse to pay from their personal account and then submit a reimbursement request. Direct payment blurs the line between personal and business expenses.
Mistake #4: Setting unreasonable compensation. If your spouse works 200 hours per year and you reimburse $30,000, that is $150 per hour. Unless your spouse has specialized skills that justify that rate, the IRS will argue the compensation is unreasonable and disallow the deduction.
Mistake #5: Forgetting about other employees. Every employee in all businesses owned by you and your spouse counts under IRC Section 105(h)(8). If you have even one other eligible employee across any of your businesses, the one-person 105-HRA does not work.
Mistake #6: Reimbursing pre-plan expenses. The 105-HRA cannot reimburse medical expenses incurred before the plan’s effective date or before the employee enrolled. Any such reimbursement is not excludable from income.
Mistake #7: Using an employment contract instead of time sheets. Employment contracts become inaccurate fast as the actual work changes. The Bradford Tax Institute warns that a time sheet showing actual work performed is far stronger audit proof than a stale contract.
Do’s and Don’ts for Section 105 Plans
| Do ✅ | Don’t ❌ |
|---|---|
| Do create a written plan document signed by both spouses — the IRS requires it for the plan to be valid | Don’t operate the plan without a written document — you lose all tax benefits |
| Do require your employee-spouse to submit weekly time sheets with dates, tasks, and hours | Don’t rely on memory or verbal descriptions of work — the IRS rejected this in Haeder |
| Do pay reimbursements from a separate business checking account | Don’t pay medical providers directly from the business account — it blurs the paper trail |
| Do research comparable pay rates and save printed evidence in your tax file | Don’t assume any amount of compensation is “close enough” — prove it with data |
| Do have your employee-spouse submit reimbursement requests with receipts at least monthly | Don’t reimburse expenses without supporting documentation — IRS requires substantiation |
| Do check whether you have other eligible employees across all your and your spouse’s businesses | Don’t assume your spouse’s side business employees don’t count — they do under IRC 414 |
| Do consider a small W-2 salary as extra proof of employment | Don’t issue a W-2 if you are not prepared to handle payroll tax withholding and filings |
Pros and Cons of a Section 105 Plan for Sole Proprietors
| Pros ✅ | Cons ❌ |
|---|---|
| 100% deduction of family medical expenses on Schedule C — premiums, co-pays, prescriptions, and more | Sole proprietor cannot participate directly — must hire a spouse as an employee |
| Reduces both income tax and self-employment tax — unlike the self-employed health insurance deduction | Requires real, documented spousal employment — fabricated arrangements are penalized |
| No federal cap on annual reimbursement amount (must be reasonable compensation) | Must maintain ongoing documentation — plan documents, time sheets, receipts, reimbursement requests |
| Reimbursements are tax-free to the employee-spouse — no income tax, no FICA | Only works for one eligible employee — additional employees trigger nondiscrimination rules |
| Can be the sole form of compensation — no payroll taxes or W-2 required | If disallowed by the IRS, all reimbursements become taxable income and deductions are lost |
| Carry-over provision allows unused amounts to roll to future years under Rev. Rul. 2002-41 | Single sole proprietors without a spouse cannot use this strategy — must consider C-corp conversion |
| Backed by IRS guidance (Rev. Rul. 71-588) and Tax Court precedent (Speltz v. Commissioner) | ACA excise tax of $100/day/employee applies if the plan covers more than one employee improperly |
How a Section 105 Plan Interacts With Other Business Structures
The 105-HRA strategy does not operate the same way across all business types. How your business files its federal tax return determines whether the spouse-employee approach is needed — or whether the owner can participate directly.
| Business Structure | Can the Owner Participate Directly? |
|---|---|
| Sole Proprietorship (Schedule C) | No — must hire spouse as employee |
| Partnership (Form 1065) | No — partners are not employees; must hire spouse. A husband-wife partnership does not qualify |
| S Corporation (Form 1120-S) | Limited — 2%+ shareholders are treated as self-employed for health plan purposes under Rev. Rul. 91-26 |
| C Corporation (Form 1120) | Yes — the owner-employee can participate directly, even without spousal employment |
| LLC | Depends on how the LLC files — follows the rules for whichever entity type it elects |
For sole proprietors who are not married, the C corporation route is the most direct path to Section 105 benefits. The C-corp is a separate legal entity, and the owner becomes an employee of that entity. This eliminates the need for spousal employment entirely.
Key Compliance Rules Beyond the IRS
A Section 105 plan is considered a group health plan under federal law. This means it must comply with rules from multiple federal agencies — not just the IRS.
ERISA (Employee Retirement Income Security Act): The plan must have a Summary Plan Description (SPD) furnished to each participant. ERISA treats Section 105 plans as employee welfare benefit plans, and compliance is mandatory even for one-person plans.
HIPAA (Health Insurance Portability and Accountability Act): Any entity processing reimbursement claims receives protected health information (PHI). This information must be stored and handled according to HIPAA privacy rules.
COBRA: Applies only to employers with 20 or more employees. Most sole proprietors using the spouse-employee strategy are well below this threshold. If COBRA applies, you must offer the terminated employee the option to continue plan participation.
ACA Market Reforms: A standalone HRA that reimburses individual insurance premiums for multiple employees must comply with ACA market reforms, including preventive care coverage without cost-sharing and dependent coverage to age 26. The one-person 105-HRA sidesteps most of these requirements because the ACA does not apply to a business with only one employee.
The ACA’s $100-Per-Day Excise Tax — What Triggers It
IRC Section 4980D imposes an excise tax of $100 per day, per affected employee on employers who maintain group health plans that fail to comply with ACA market reform requirements. For a single employee, that penalty could reach $36,500 per year. For five employees, it jumps to $182,500 per year.
This penalty applies when a standalone HRA reimburses individual health insurance premiums for more than one employee without meeting the requirements of a QSEHRA, ICHRA, or integrated HRA. The one-person 105-HRA avoids this penalty entirely because a business with a single employee is not subject to the ACA’s market reform rules.
The takeaway is stark: if you have multiple employees, do not set up a one-person 105-HRA. Use a QSEHRA, ICHRA, or group coverage HRA that is designed to be ACA-compliant.
Relevant Court Rulings Every Sole Proprietor Should Know
| Case | Outcome | Key Lesson |
|---|---|---|
| Speltz v. Commissioner (T.C. Summ. Op. 2006-25) | Taxpayer won | Written plan + documented hours + reasonable pay = IRS loses on all counts |
| Haeder v. Commissioner (T.C. Memo. 2001-7) | IRS won | No work documentation + vague testimony = no employer-employee relationship |
| Shelley v. Commissioner (T.C. Memo. 1994-432) | IRS won | Taxpayer did not document any services the spouse performed |
| Tschetter v. Commissioner (T.C. Memo. 2003-326) | Clarified rules | Plan does not need to be in writing as long as participant has notice/knowledge — but written plans are far safer |
The pattern is unmistakable. Taxpayers who document the employment relationship, the work performed, and the plan terms win. Taxpayers who rely on oral agreements, vague testimony, and incomplete records lose.
FAQs
Can a sole proprietor deduct their own medical expenses through a Section 105 plan?
No. IRC Section 105(g) treats sole proprietors as self-employed, not employees. They cannot receive tax-free reimbursements from their own Section 105 plan.
Does the employee-spouse need to receive cash wages?
No. The 105-HRA reimbursement can be the sole form of compensation. No W-2 or payroll taxes are required if no cash wages are paid.
Can a sole proprietor use a Section 105 plan without a spouse?
No. A sole proprietor without a spouse cannot use the spouse-employee strategy. Incorporating as a C corporation is the alternative path.
Does a Section 105 plan reduce self-employment tax?
Yes. The reimbursements are deducted on Schedule C, which reduces net business income. Lower net business income means lower self-employment tax.
Is the $100-per-day ACA excise tax a real risk?
Yes. IRC Section 4980D imposes this penalty on noncompliant group health plans. A one-person 105-HRA is exempt, but multi-employee plans face this risk.
Can my spouse work part-time and still qualify?
Yes. The Tax Court in Speltz upheld a plan where the spouse worked an average of 12.5 hours per week. Part-time employment is valid if documented.
Does a husband-wife partnership qualify for a 105-HRA?
No. A partnership between spouses does not qualify because both partners are self-employed. Neither partner is an employee of the other.
Can the 105-HRA reimburse dental and vision expenses?
Yes. Any expense qualifying under IRC Section 213(d) is eligible, including dental, vision, mental health, and prescription costs.
Do I need a third-party administrator for a 105-HRA?
No. A sole proprietor can self-administer the plan. Third-party administrators add cost but help ensure compliance with IRS and ERISA rules.
Can I set up a Section 105 plan mid-year?
Yes. The plan can begin on any date. It cannot reimburse expenses incurred before the plan’s effective date or before the employee enrolls.
What happens if the IRS disallows my Section 105 plan?
Yes, there are consequences. All reimbursements become taxable income. The Schedule C deductions are disallowed, and you may owe back taxes plus penalties and interest.
Can a Section 105 plan cover my children?
Yes. The plan covers the employee, the employee’s spouse, dependents, and any child of the employee who has not reached age 27.
Is there a maximum reimbursement amount for a 105-HRA?
No. There is no federal cap, unlike the QSEHRA. The reimbursement amount must be reasonable compensation for the employee-spouse’s work.
Do Section 105 reimbursements count as taxable income for my spouse?
No. Reimbursements under a compliant Section 105(b) plan are excluded from the employee-spouse’s gross income and are not subject to income or payroll taxes.
Can I have a 105-HRA and an HSA at the same time?
Yes. Special rules apply to which expenses each plan can reimburse. The HRA may need to be limited to dental, vision, or post-deductible expenses to preserve HSA eligibility.
Related reading
- How Does a Section 105 Plan Work? (w/Examples) + FAQs
- Can I Cover My Children Under a Section 105 Plan? (w/Examples) + FAQs
- Is Section 105 Reimbursement Taxable Income? (w/Examples) + FAQs
- Can I Set Up a Section 105 Plan for Myself? (w/Examples) + FAQs
- Does My Spouse Need to Be a W-2 Employee for Section 105? (w/Examples) + FAQs
- Does My Spouse Need to Do Actual Work for Section 105? (w/Examples) + FAQs