Yes, you can cover your children under a Section 105 plan. IRC Section 105(b) specifically allows tax-free reimbursement of medical expenses for an employee’s children who have not reached age 27 by the end of the tax year. This includes biological children, stepchildren, adopted children, and eligible foster children — without requiring them to pass the residency, support, or other dependency tests under Section 152 of the tax code.
The Affordable Care Act also requires any group health plan that offers dependent coverage to extend that coverage to children until age 26. About 49% of small businesses in the U.S. do not offer any health benefits at all, which makes Section 105 plans one of the most powerful and underused tools for covering your kids tax-free while deducting the cost as a business expense.
Here’s what you’ll learn in this article:
- 👶 Which children qualify under Section 105(b) — and the specific IRS definition that goes beyond biological kids
- 💰 How your business entity type (C-corp, S-corp, sole prop, partnership) changes your child’s eligibility and tax treatment
- ⚖️ Divorced parent rules — why Section 152(e) lets both parents claim the child for Section 105 purposes
- 📋 Real-world examples and scenarios showing how families actually use these plans to cover their children
- 🚫 Critical mistakes to avoid that can trigger IRS penalties and disqualify your child’s reimbursements
What a Section 105 Plan Actually Does
A Section 105 plan is an employer-sponsored benefit that reimburses employees tax-free for medical expenses and health insurance premiums. The employer sets a monthly or annual allowance, and employees submit eligible expenses for reimbursement. The plan gets its name from Section 105 of the Internal Revenue Code, which governs how these reimbursements are taxed.
The employer — not the employee — funds the plan. Employees cannot contribute through salary deductions. This is a key difference from health savings accounts (HSAs) and flexible spending accounts (FSAs), where employee contributions play a bigger role.
Section 105 plans come in several forms, including Individual Coverage HRAs (ICHRAs), Qualified Small Employer HRAs (QSEHRAs), Group Coverage HRAs (GCHRAs), and traditional self-insured medical reimbursement plans. Each type has different rules for contribution limits, business size, and whether a group health insurance policy is also required.
The power of these plans is in the tax treatment. Reimbursements are excluded from the employee’s gross income under IRC Section 105(b) and are deductible as a business expense for the employer. The employer also avoids FICA and FUTA taxes on the reimbursed amounts.
The IRS Definition of “Child” Under Section 105(b)
The IRS uses a specific definition of “child” for Section 105 purposes. Under IRC Section 152(f)(1), which Section 105(b) references, a child includes:
- A son or daughter (biological)
- A stepson or stepdaughter
- A legally adopted individual or an individual lawfully placed with the employee for legal adoption
- An eligible foster child
This definition is broader than many business owners realize. You do not need to claim the child as a tax dependent on your return for them to qualify under your Section 105 plan. The IRS confirmed in Notice 2010-38 that the Section 152(c) age limit, residency, support, and other dependency tests do not apply.
This means your 25-year-old daughter who lives in another state, earns her own income, and files her own tax return can still be covered under your Section 105 plan — as long as she hasn’t turned 27 by December 31 of the tax year.
Age 26 vs. Age 27: A Crucial Distinction
Many business owners confuse the ACA’s age-26 coverage mandate with the Section 105(b) tax exclusion. These are two different rules with two different age cutoffs.
| Rule | Age Limit |
|---|---|
| ACA dependent coverage mandate (Section 2714 of the PHS Act) | Must offer coverage until child turns 26 |
| IRC Section 105(b) tax exclusion for reimbursements | Tax-free until end of tax year child turns 26 (i.e., effectively through age 27 in the tax year) |
The ACA requires group health plans — including Section 105 plans — that make dependent coverage available to extend it through age 26. The IRC Section 105(b) amendment goes one step further for tax purposes, allowing reimbursements to remain tax-free for any child who has not reached age 27 as of the end of the taxable year.
A practical example: if your son turns 26 on March 15, 2026, the ACA mandate no longer requires the plan to cover him after that birthday. But any reimbursements made for his medical expenses through December 31, 2026 are still tax-free under Section 105(b), because he has not yet turned 27 by the end of the tax year. Your plan document, however, must allow this extended coverage — the tax code permits it, but your written plan document controls what’s actually reimbursable.
How Your Business Entity Changes Everything
Your business structure has a direct impact on whether your children receive tax-free benefits under a Section 105 plan. The IRS treats business owners differently depending on entity type.
C-Corporation Owners
C-corp owners have the best deal. A C-corp owner who works in the business is treated as a regular W-2 employee. The owner can participate in the company’s Section 105 plan directly, and reimbursements for the owner’s children are fully tax-free. The business deducts the reimbursements as an ordinary business expense.
There are no special restrictions on C-corp owner participation. The owner’s children — biological, step, adopted, and foster — qualify just like any other employee’s children.
Sole Proprietors and Single-Member LLCs
Sole proprietors cannot participate in their own Section 105 plan. The IRS considers a sole proprietor self-employed, not an employee, so reimbursements to the owner are not tax-free.
The workaround is the spouse-employee strategy. If the sole proprietor’s spouse is a bona fide W-2 employee of the business, the spouse can participate in the Section 105 plan. The plan would be set up in the spouse’s name, and the sole proprietor (plus the couple’s children) would be listed as dependents. This arrangement makes the entire family’s medical expenses reimbursable and tax-free.
Your children benefit from this structure because they are dependents of the participating employee-spouse. The key requirement is that the spouse must perform legitimate work for the business and receive reasonable compensation.
S-Corporation Owners (2% or Greater)
S-corp owners who hold more than 2% of the company’s shares face the harshest restrictions. The IRS treats these owners as self-employed for health benefit purposes. Reimbursements are subject to federal income tax, which removes much of the plan’s appeal.
Critically, the IRS extends this treatment to family members of 2%+ S-corp owners. Your spouse, children, parents, and grandchildren are treated as if they hold the same ownership interest. This means the spouse-employee workaround that works for sole proprietors does not work for S-corps.
Your children who work for the S-corp are treated the same as you — their reimbursements face income tax. The Section 105 plan can still track expenses, but the core tax-free benefit is largely eliminated for the owner’s family.
Partnerships and Multi-Member LLCs
Partners in a partnership (and LLC members taxed as partnerships) follow rules similar to sole proprietors. They are self-employed and cannot directly receive tax-free reimbursements. The spouse-employee arrangement works here, unless both spouses are partners — a husband-wife partnership does not qualify.
| Business Entity | Owner Participates Directly? | Children Covered Tax-Free? | Spouse-Employee Workaround? |
|---|---|---|---|
| C-Corporation | Yes | Yes | Not needed |
| Sole Proprietorship | No | Yes, through spouse-employee arrangement | Yes |
| S-Corporation (2%+ owner) | No (limited tax benefit) | No (treated as owner) | No |
| Partnership | No | Yes, through spouse-employee arrangement | Yes (unless spouse is also a partner) |
Divorced Parents Get a Unique Advantage
IRC Section 105(b) contains a provision that specifically addresses children of divorced parents. It states: “Any child to whom section 152(e) applies shall be treated as a dependent of both parents.”
This is a powerful rule. In a typical divorce, only one parent can claim the child as a tax dependent in a given year. But for Section 105 purposes, both parents can cover the child under their respective plans. This means if both parents have Section 105 plans through their employers or businesses, the child can receive tax-free reimbursements from either parent’s plan.
Scenario: Divorced Parents Both Covering a Child
Mark and Lisa are divorced. Their 12-year-old daughter, Sophie, lives with Lisa. Mark claims Sophie as a dependent on his tax return per their custody agreement.
| Situation | Result |
|---|---|
| Mark submits Sophie’s dental bill to his employer’s Section 105 plan | Tax-free — Sophie is Mark’s child under Section 105(b) |
| Lisa submits Sophie’s prescription costs to her employer’s Section 105 plan | Tax-free — Section 152(e) treats Sophie as Lisa’s dependent too |
| Both parents submit the same expense | Not allowed — the same expense cannot be reimbursed twice |
The only restriction is that the same expense cannot be double-reimbursed. Each parent can submit different expenses for the same child and receive tax-free treatment on both sides.
Stepchildren, Foster Children, and Adopted Children
The IRS definition of “child” under Section 105(b) is deliberately broad. It goes beyond biological children to include stepchildren, adopted children, children placed for adoption, and eligible foster children.
Stepchildren qualify the moment the marriage occurs. If you marry someone who has a 10-year-old child from a previous relationship, that child is your stepchild and is immediately eligible under your Section 105 plan. You do not need to formally adopt the child.
Adopted children qualify as soon as the adoption is finalized. Children placed with the employee for legal adoption also qualify — even before the adoption is complete. This is an important distinction because adoption proceedings can take months or years.
Eligible foster children qualify if they are placed with the employee by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction. Informal arrangements where you care for a friend’s or relative’s child do not meet this definition.
Scenario: Blended Family Coverage
David runs a C-corporation. He recently married Jennifer, who has two children from her first marriage (ages 8 and 14). David and Jennifer also have a newborn together.
| Child | Relationship to David | Eligible Under David’s Section 105 Plan? |
|---|---|---|
| Jennifer’s 8-year-old | Stepchild | Yes |
| Jennifer’s 14-year-old | Stepchild | Yes |
| Newborn | Biological child | Yes |
All three children qualify for tax-free reimbursements under David’s Section 105 plan. David does not need to adopt Jennifer’s children for them to be eligible. The stepchild relationship alone satisfies the IRS definition.
Children With Disabilities Beyond Age 26
The standard Section 105(b) tax exclusion ends when a child turns 27 (as of the end of the tax year). But what about adult children with disabilities who remain dependent on their parents?
Here, the general dependency rules of IRC Section 152 come back into play. Section 105(b) allows tax-free reimbursements for “dependents as defined in section 152.” If your adult child over age 26 qualifies as your dependent under Section 152 — which can happen if the child is permanently and totally disabled and meets the residency and support tests — their medical expenses can still be reimbursed tax-free.
This creates two separate paths to eligibility for a child with a disability:
| Path | Age Requirement | Dependency Tests Required? |
|---|---|---|
| “Child who has not attained age 27” | Under 27 at end of tax year | No — no residency, support, or other tests |
| “Dependent under Section 152” | No age limit if permanently and totally disabled | Yes — must meet residency, support, and relationship tests |
A 30-year-old adult child who is permanently and totally disabled, lives with the employee, and receives more than half of their support from the employee would qualify as a dependent under Section 152. That child’s medical expenses can be reimbursed tax-free through the parent’s Section 105 plan regardless of age.
ICHRA, QSEHRA, and Your Children
The two most popular Section 105 HRA types for small businesses are the Individual Coverage HRA (ICHRA) and the Qualified Small Employer HRA (QSEHRA). Both can cover children, but the rules differ.
ICHRA and Children
An ICHRA has no contribution limits and is available to businesses of any size. The employer decides whether to extend the benefit to dependents in the plan document. If the plan allows dependent coverage, qualified dependents include biological, adopted, or stepchildren up to age 26.
Employees participating in an ICHRA must have individual health insurance coverage. If the employer allows dependents, the employee can enroll in a family plan on the individual market that covers their children. The ICHRA then reimburses both the employee’s and children’s premiums and eligible out-of-pocket costs.
Important: employees who accept an ICHRA cannot also receive premium tax credits from the Health Insurance Marketplace for the same coverage. If the ICHRA is considered “affordable,” the employee and their dependents lose access to those subsidies.
QSEHRA and Children
A QSEHRA is designed for businesses with fewer than 50 full-time employees that do not offer group health insurance. For 2026, the contribution limits are $6,450 for self-only coverage and $13,100 for family coverage per year.
When a QSEHRA provides family-level reimbursements, the employee’s children are covered under the family allowance. Employees must have minimum essential coverage (MEC) — such as an individual marketplace plan — to receive reimbursements.
The QSEHRA does affect premium tax credit eligibility. If an employer provides a QSEHRA to an employee’s dependents, the dependents’ premium tax credit is reduced by the QSEHRA allowance amount. Depending on the allowance, the children may receive a reduced tax credit or no credit at all.
ICHRA vs. QSEHRA for Covering Children
| Feature | ICHRA | QSEHRA |
|---|---|---|
| Employer size restriction | None | Fewer than 50 FTEs |
| Annual contribution limit | None | $6,450 (self) / $13,100 (family) in 2026 |
| Dependent coverage | Employer chooses in plan document | Employer chooses self-only or family rate |
| Individual insurance required? | Yes | Yes (MEC required) |
| Premium tax credit interaction | Cannot collect PTC if participating in ICHRA | PTC reduced by QSEHRA allowance |
How Marketplace Subsidies Are Affected
Covering your children under a Section 105 plan can directly reduce or eliminate their eligibility for premium tax credits on the Health Insurance Marketplace. This is a trade-off that many business owners overlook.
With a QSEHRA, the subsidy reduction is dollar-for-dollar. If your QSEHRA provides $500/month in family coverage, your child’s marketplace premium tax credit is reduced by that amount. If the QSEHRA allowance is large enough, the child may lose the premium tax credit entirely.
With an ICHRA, the rules are even more rigid. If the employer offers an affordable ICHRA, the employee and covered dependents are completely ineligible for marketplace premium tax credits. The employee can opt out of the ICHRA to preserve subsidy eligibility, but they must waive the entire benefit — they cannot keep it for themselves and waive it only for a child.
Scenario: Marketplace Subsidy vs. QSEHRA
Rachel runs a small business with eight employees. She offers a QSEHRA with a $13,100 annual family allowance ($1,091.66/month). Her employee Tom has two children enrolled in a marketplace plan.
| Without QSEHRA | With QSEHRA |
|---|---|
| Tom’s family marketplace premium: $1,200/month | Tom’s family marketplace premium: $1,200/month |
| Premium tax credit: $700/month | Premium tax credit: reduced by $1,091.66/month |
| Tom pays: $500/month out-of-pocket | Tom receives $1,091.66/month in tax-free QSEHRA reimbursement; PTC may be $0 |
In this case, the QSEHRA more than offsets the lost premium tax credit, making it a net win for Tom’s family. But if the QSEHRA allowance were smaller — say $400/month — and it reduced a $700 tax credit to $300, Tom might only break even. Always run the numbers before assuming a Section 105 plan is better than marketplace subsidies for your employees’ children.
Setting Up Your Section 105 Plan to Cover Children
Covering your children requires specific steps. It is not automatic — the plan document must explicitly state that dependents are eligible for reimbursement.
Step-by-Step Process
Step 1: Choose your plan type. Decide whether an ICHRA, QSEHRA, GCHRA, or traditional self-insured medical reimbursement plan fits your business. Your choice depends on business size, budget, and whether you offer group health insurance.
Step 2: Draft the plan document. The IRS requires a formal written plan document. This document must specify who is eligible for reimbursement, including whether dependents (children) are covered, what expenses are reimbursable, and the allowance amounts.
Step 3: Define “dependent” in the document. Specify that eligible children include biological children, stepchildren, adopted children, and foster children under age 27 (or dependents under Section 152 for disabled adult children). If you want to cover children of divorced employees under both parents’ plans, the document should reflect the Section 152(e) rule.
Step 4: Set allowance amounts. For QSEHRAs, you must stay within the 2026 federal limits ($6,450 self-only / $13,100 family). For ICHRAs and other plans, there is no federal cap, but you must offer the same terms to employees in the same class.
Step 5: Ensure compliance. Your plan must comply with ERISA, HIPAA, COBRA (if 20+ employees), and ACA rules. Many businesses use third-party administrators to handle compliance and expense review.
Step 6: Communicate to employees. Provide a summary plan description (SPD) to every participant. If you modify the plan, the ACA requires 60 days advance notice of material modifications.
Mistakes to Avoid When Covering Children
Getting child coverage wrong under a Section 105 plan can lead to disqualified reimbursements, back taxes, and IRS penalties. These are the most common errors.
Mistake #1: No written plan document. The IRS requires a formal written document. Verbal agreements do not satisfy the requirement. Without a proper document, all reimbursements — including those for your children — can be disqualified and treated as taxable income.
Mistake #2: Assuming S-corp owner’s children get tax-free treatment. If you own more than 2% of an S-corporation, your children are treated as if they hold the same ownership. Reimbursements for their medical expenses are subject to federal income tax. Many S-corp owners set up Section 105 plans without realizing this limitation.
Mistake #3: Reimbursing an ineligible child. A niece, nephew, or friend’s child does not meet the IRS definition of “child” under Section 152(f)(1). Reimbursing expenses for ineligible individuals results in disallowed deductions and potential penalties.
Mistake #4: Double-reimbursing the same expense. If both divorced parents have Section 105 plans, the same medical bill cannot be submitted to both plans. Only different expenses can be split between the two parents’ plans.
Mistake #5: Ignoring marketplace subsidy interactions. Adding children to a QSEHRA or ICHRA without calculating the impact on premium tax credits can leave employees worse off financially than they were before.
Mistake #6: Not updating the plan document for blended families. When you remarry or gain stepchildren, the plan document should already cover stepchildren — but if it uses narrow language, you may need to amend it. Failing to update creates a gap where reimbursements could be denied.
Mistake #7: Covering a child over age 26 without verifying disability status. The tax-free treatment for children over 26 requires the child to be permanently and totally disabled and meet Section 152 dependency tests. Simply continuing to reimburse expenses without verifying eligibility exposes you to IRS scrutiny.
Do’s and Don’ts for Covering Children
| Do ✅ | Don’t ❌ |
|---|---|
| Do include dependent eligibility in your written plan document — the IRS won’t assume it | Don’t assume your children are automatically covered without checking the plan document |
| Do verify the child’s age before each plan year to confirm they’re under 27 | Don’t continue reimbursing a child over 26 without confirming Section 152 dependent status |
| Do keep receipts and documentation for every reimbursed expense for 10 years | Don’t reimburse expenses based on verbal requests — proper substantiation is required |
| Do calculate marketplace subsidy impacts before extending coverage to employees’ children | Don’t ignore the premium tax credit reduction that comes with QSEHRA family coverage |
| Do consult a tax professional if you’re an S-corp owner considering a Section 105 plan | Don’t use the spouse-employee workaround for an S-corp — it doesn’t work for 2%+ owners |
| Do use a third-party administrator if you’re unsure about ERISA, HIPAA, and ACA compliance | Don’t self-administer the plan without understanding the compliance requirements — fines are steep |
Pros and Cons of Covering Children Under a Section 105 Plan
| Pros ✅ | Cons ❌ |
|---|---|
| Tax-free reimbursements — children’s medical and insurance expenses are excluded from gross income under IRC Section 105(b) | S-corp family limitation — children of 2%+ S-corp owners lose the tax-free benefit |
| Broad definition of “child” — stepchildren, adopted children, and foster children all qualify without extra dependency tests | Plan document required — you must have a formal written document, and it must explicitly include dependents |
| Divorced parent flexibility — both parents can cover the same child under separate Section 105 plans | Marketplace subsidy reduction — QSEHRA and ICHRA coverage can reduce or eliminate children’s premium tax credits |
| No age/residency/support tests — children under 27 qualify regardless of where they live or how much they earn | Compliance burden — plans must comply with IRS, ERISA, HIPAA, COBRA, and ACA regulations |
| Business deduction — the employer deducts all reimbursements as a business expense and avoids FICA/FUTA on those amounts | Sole proprietor limitation — sole proprietors can only access the benefit indirectly through a spouse-employee arrangement |
| Disabled adult children covered — children over 26 who are permanently and totally disabled may still qualify under Section 152 | Administration costs — third-party administrators charge fees, and self-administration risks compliance errors |
Key Entities and How They Interact
Several organizations and legal frameworks govern how children are covered under Section 105 plans. Understanding who does what helps you stay compliant.
The IRS administers the tax code, including IRC Sections 105, 106, and 152. The IRS determines which reimbursements are tax-free and which are not. IRS Notice 2010-38 clarified the rules for adult children after the ACA was passed.
The Department of Labor (DOL) enforces ERISA rules. Your Section 105 plan is an employee welfare plan under ERISA, which requires a summary plan description, fiduciary responsibilities, and reporting obligations.
The Department of Health and Human Services (HHS) oversees the ACA provisions, including the requirement that group health plans offering dependent coverage must extend it to children until age 26. HHS also administers the Health Insurance Marketplace, which interacts with ICHRA and QSEHRA affordability determinations.
State insurance departments may impose additional requirements depending on where your business operates. Some states have their own mandates for dependent coverage that exceed the federal age-26 floor. Always check your state’s rules.
Court Rulings and IRS Guidance Worth Knowing
IRS Notice 2010-38 is the foundational guidance document for covering adult children under Section 105 plans. It confirmed that no age, residency, or support tests apply for children under 27. It also confirmed that the IRS would retroactively amend Section 106 regulations to exclude employer-paid coverage for adult children from gross income, effective March 30, 2010.
IRS Notice 2015-17 provided [transition relief for S-corporation owners](https://bradfordtaxinstitute.com/readers/Topic-Medical%20(for%20105%20plans.aspx) regarding individual health insurance reimbursements. This notice allowed certain S-corp arrangements to avoid the $100-per-day-per-employee penalty during 2014 and 2015, though that relief has since expired.
The 21st Century Cures Act of 2016 created the QSEHRA, giving small employers a new Section 105 plan option. This law specifically addressed businesses with fewer than 50 employees that couldn’t afford group health insurance but wanted to help employees — and their children — pay for individual coverage.
FAQs
Can I cover my stepchild under a Section 105 plan?
Yes. Stepchildren qualify under IRC Section 152(f)(1), which Section 105(b) references. No adoption is required. They are eligible as soon as the marriage occurs.
Does my child need to live with me to qualify?
No. For children under age 27, the IRS does not apply residency, support, or other dependency tests. Your child qualifies regardless of where they live.
Can both divorced parents cover the same child?
Yes. IRC Section 105(b) states that a child under Section 152(e) is treated as a dependent of both parents. Each parent can submit different expenses.
Can I cover my child’s spouse under my Section 105 plan?
No. Your child’s spouse is not your “child” under Section 152(f)(1). They would need their own employer-sponsored coverage or individual plan.
Is there a limit on how much I can reimburse for my child’s expenses?
It depends. QSEHRAs cap family coverage at $13,100 for 2026. ICHRAs and traditional self-insured plans have no federal limit.
Can my child use an ICHRA to buy their own insurance?
No. The ICHRA belongs to the employee. The employee buys a family plan covering the child and submits the premium for reimbursement.
Do I need to offer dependent coverage to all employees?
Yes, if you offer it to any employee. Nondiscrimination rules under Section 105(h) require that benefits available to highly compensated employees must be available to all participants.
Can my 28-year-old disabled child be covered?
Yes. If your child is permanently and totally disabled and meets the Section 152 dependency tests, they qualify as a dependent regardless of age.
Will covering my children affect their marketplace subsidies?
Yes. QSEHRA allowances reduce premium tax credits dollar-for-dollar. ICHRA participation eliminates PTC eligibility entirely if the offer is considered affordable.
Can I cover my foster child under a Section 105 plan?
Yes. Eligible foster children are included in the IRS definition of “child” under Section 152(f)(1). They must be placed by an authorized agency or court order.
Can an S-corp owner’s child receive tax-free Section 105 reimbursements?
No. Children of 2%+ S-corp owners are treated as owners for health benefit purposes. Reimbursements are subject to federal income tax.
Does my plan document need to specifically mention children?
Yes. The plan document must state that dependents are eligible. Without this language, reimbursements for children’s expenses can be disqualified by the IRS.
Related reading
- Can Grandchildren Be Added to Health Insurance? (w/Examples) + FAQs
- How Does a Section 105 Plan Work? (w/Examples) + FAQs
- Can a Sole Proprietor Have a Section 105 Plan? (w/Examples) + FAQs
- Can I Deduct Section 105 Reimbursements? (w/Examples) + FAQs
- Can I Set Up a Section 105 Plan for Myself? (w/Examples) + FAQs
- Can Section 105 Reimburse Long-Term Care Insurance? (w/Examples) + FAQs
- Is Section 105 Reimbursement Taxable Income? (w/Examples) + FAQs