QSEHRA: The Complete Guide for Small Business Owners

When my company hit 8 employees, the question I heard most often, from every candidate and every employee, was not about salary or PTO. It was "Do you offer benefits?" and my honest answer was always the same: "We are too small to offer group health insurance at a reasonable cost." This guide shows you the better answer I found, whether you qualify, and how to set it up.

Group health insurance for a company with 8 employees is expensive, complicated, and often requires minimum participation rates that are hard to meet when half your team is under 30 and does not see the value. The quotes I received ranged from $400 to $800 per employee per month for plans that required 70% participation. The administrative burden of managing enrollment, compliance, and renewals was a full-time job I did not have anyone to assign to.

Then I discovered the QSEHRA. A Qualified Small Employer Health Reimbursement Arrangement lets small businesses with fewer than 50 employees reimburse employees for individual health insurance premiums and medical expenses, tax-free for the employee and tax-deductible for the employer. No group plan to manage. No minimum participation. No insurance company to negotiate with. I set a monthly allowance, employees bought their own insurance, and I reimbursed them up to the limit.

The guide also covers the contribution limits, eligible expenses, the notice rules, onboarding, and how a QSEHRA compares with an ICHRA (Individual Coverage Health Reimbursement Arrangement) and with group insurance. At FirstHR, we handle the documentation side of benefits: delivering the required QSEHRA notice during onboarding, collecting e-signed acknowledgments, storing plan documents, and tracking employee eligibility through the HRIS.

What Is a QSEHRA?

A QSEHRA (Qualified Small Employer Health Reimbursement Arrangement) is a formal, IRS-approved benefit that allows small employers to reimburse employees for individual health insurance premiums and qualifying medical expenses. Created by the 21st Century Cures Act (signed December 13, 2016, effective January 1, 2017), the QSEHRA was designed specifically for small businesses that cannot afford or do not want to offer traditional group health insurance.

The key distinction: a QSEHRA is not health insurance. It is a health reimbursement arrangement (HRA). The employer does not buy a health plan, negotiate with an insurance carrier, or manage enrollment; it sets a budget, employees buy their own coverage, and it reimburses them. That structure lets a small business offer a health benefit without the complexity, cost, and minimum participation requirements of group insurance.

How a QSEHRA Works: Step by Step

The QSEHRA process follows six steps, from plan setup through reimbursement and reporting. The employer controls the budget and the plan design. The employee controls which insurance they buy and which expenses they submit.

The cycle repeats every plan year: you review the reimbursement amounts against the new IRS limits and deliver updated notices to employees. For anyone who becomes eligible mid-year, the allowance is prorated across the months of eligibility remaining in the plan year.

One question comes up at setup more than any other: where the money comes from. A QSEHRA is funded entirely by the employer out of general business funds. Employees cannot contribute, there is no salary reduction and no cafeteria plan election, and there is no account to prefund. Nothing leaves the business until somebody submits a substantiated claim.

Employer Eligibility: Who Can Offer a QSEHRA

Two conditions must be met simultaneously before you can offer a QSEHRA: you were not an applicable large employer in the prior calendar year, and you offer no group health plan to any employee. There are no exceptions or workarounds. The checklist below adds the rules the arrangement itself has to follow once you qualify.

The 50-Employee Threshold

The employer must not be an applicable large employer under IRC Section 4980H(c)(2), which in practice means fewer than 50 full-time equivalent (FTE) employees averaged across the prior calendar year. Full-time means 30+ hours per week or 130+ hours per month under the Affordable Care Act (ACA) definition.

Part-time people are folded in by arithmetic, not by headcount. Add up the monthly hours of everyone who is not full time, counting no more than 120 hours for any one person, divide by 120, and add the result to your full-time count. Run that for each month and average the twelve results, per the IRS applicable large employer test.

The count includes all common-law employees but excludes sole proprietors, partners in a partnership, and 2%+ shareholders in an S-corporation. Run the count the same way you would for ACA purposes, and run it again before each plan year rather than assuming last year's answer still holds.

The No Group Health Plan Requirement

The employer must not offer a group health insurance plan to any employee. This is absolute: if you offer group coverage to even one class of employees (full-time, executives, any subset), you cannot offer a QSEHRA to anyone. That rule is also a common reason employers choose an ICHRA, which allows group coverage for some employee classes and an HRA for others.

The Uniformity Requirement

The QSEHRA must be provided on the same terms to all eligible employees. The employer cannot offer different amounts based on job title, department, or compensation level. Two variations are allowed: by the employee's age and by the number of family members covered.

Both variations have to track the price of a real baseline policy. Under IRS Notice 2017-67, the benefit may vary in proportion to the cost of an individual-market policy that is minimum essential coverage and is available for purchase by at least one eligible employee. Many small employers skip the modeling: one amount for self-only coverage, one for family.

Employee Eligibility

Not every employee must be included in a QSEHRA. IRC Section 9831(d)(3)(A) names the categories a plan document may carve out, and every carve-out has to be written as a class rather than picked person by person.

One trap sits inside the carve-outs. If you do decide to cover an excludable class, IRS Notice 2017-67 requires that those employees get the arrangement on the same terms as everybody else. A smaller allowance for part-timers you chose to include breaks the same terms requirement.

The most important employee-side requirement: to receive tax-free reimbursements, the employee must have minimum essential coverage (MEC). This includes marketplace plans (Bronze, Silver, Gold, Platinum), most employer-sponsored plans (from a spouse or parent), Medicare, Medicaid, CHIP, and TRICARE. Short-term health insurance plans and health care sharing ministry memberships generally do not qualify as MEC.

QSEHRA Contribution Limits

The IRS sets maximum annual reimbursement amounts for QSEHRAs, adjusted each year for inflation. You can set your allowance at any amount up to these maximums. These are annual limits that prorate for employees who join mid-year.

The 2026 ceiling is $6,450 for self-only coverage and $13,100 for family coverage, per Rev. Proc. 2025-32. That is $537.50 and just over $1,091 a month.

The cap is annual, so test any monthly figure against it. A family allowance of $1,091.67 a month comes to $13,100.04 over twelve months, 4 cents over the limit, and IRS Notice 2017-67 does not permit rounding to an amount above the statutory limit. Set monthly amounts that stay within the annual cap when multiplied by twelve, such as $1,091 for family coverage.

How Proration Works

For employees who join the QSEHRA mid-year, the annual limit is prorated by the number of months of coverage. An employee who starts on July 1 with a self-only plan receives up to 6/12 of the annual maximum for that year. The prorated amount must be calculated and included in their written notice.

QSEHRA Eligible Expenses

A QSEHRA can reimburse any expense that qualifies as a medical expense under IRC Section 213(d). That is the same definition the IRS uses for itemized medical deductions, and the working list lives in IRS Publication 502. The employer can reimburse all Section 213(d) expenses or limit reimbursement to insurance premiums.

The pharmacy row is the one most plan documents get wrong. Over-the-counter medicines once needed a prescription to be reimbursable, and the CARES Act removed that requirement for amounts paid after December 31, 2019, adding menstrual care products at the same time.

The IRS confirms the change reaches HRAs as well as health savings accounts (HSAs) and health flexible spending arrangements (FSAs). Any plan document drafted against the older rule needs that line updated.

The employer must specify in the plan terms which expenses are eligible. The two most common approaches: (1) reimburse all Section 213(d) expenses (broadest coverage, most appreciated by employees, harder to administer), or (2) reimburse only health insurance premiums (simplest to administer, easiest to verify). Many small employers start with premiums-only and expand to all Section 213(d) expenses after they have the administration in place.

Tax Benefits of a QSEHRA

A QSEHRA is deductible to the business, excluded from the employee's income where they hold minimum essential coverage, and outside Social Security, Medicare, and federal unemployment tax on both sides. That last piece holds even when coverage lapses, which is the part most summaries get wrong.

The row that surprises people is FICA. When an employee loses minimum essential coverage, the reimbursement becomes taxable income in Box 1. Notice 2017-67 still keeps it out of Social Security, Medicare, and federal unemployment wages under IRC Sections 3121(a)(2)(B) and 3306(b)(2)(B), and out of income tax withholding under Section 3401(a)(20). The employee owes income tax on it at filing; the payroll taxes never attach.

A salary increase is the obvious alternative, and it fares worse. Handing someone $5,000 more so they can buy their own policy costs the business another 7.65% in employer-side FICA on the raise, and the employee pays income tax plus their own 7.65% before the first premium is paid. The same $5,000 routed through a QSEHRA is deductible to the business, carries no FICA on either side, and reaches an employee with coverage whole.

What the IRS Rules on Health Insurance Reimbursement Require

The IRS rules for health insurance reimbursement come down to one point: an employer cannot simply hand an employee money toward their premium and treat it as a tax-free benefit.

The IRS treats an arrangement that pays or reimburses individual policy premiums as a group health plan in its own right. That plan cannot be integrated with an individual policy to satisfy the ACA market reforms.

Getting that wrong is expensive. Such an arrangement can carry an excise tax of $100 per day per affected employee under Internal Revenue Code Section 4980D, which works out to $36,500 per year per employee, according to IRS guidance on employer health care arrangements. The QSEHRA exists precisely because Congress had to create a lawful route to the same outcome.

Three things separate a compliant arrangement from an informal one: a written notice to every eligible employee at least 90 days before the plan year, reimbursement paid only against substantiated expenses, and tax-free treatment limited to employees who carry minimum essential coverage.

A flat monthly amount handed over with no documentation is not a QSEHRA. Paid as ordinary taxable wages, a cash stipend is lawful; paid as a tax-free premium reimbursement without that structure, it is not.

QSEHRA vs ICHRA: Which HRA Is Right for Your Business?

The ICHRA (Individual Coverage Health Reimbursement Arrangement) applies to plan years beginning on or after January 1, 2020, and arrived as a more flexible alternative to the QSEHRA. Both let an employer reimburse employees for individual health insurance. They differ in who can offer one, how much, and to whom.

You may also see the ICHRA under a second name. The Centers for Medicare & Medicaid Services (CMS) and the Small Business Administration (SBA) promote it as the CHOICE Arrangement, and CMS states that CHOICE Arrangements were previously known as ICHRAs. The rename is administrative: the regulation at 26 CFR 54.9802-4 is unchanged and still uses the individual coverage HRA term.

When to Choose QSEHRA

Choose a QSEHRA if you have fewer than 50 FTEs, you do not offer group health insurance, and you want to offer the same benefit to all eligible employees with minimal administrative complexity. The QSEHRA is simpler to set up, simpler to administer, and has clear IRS-set limits that make budgeting predictable.

When to Choose ICHRA

Choose an ICHRA if you are at or above the 50-employee applicable large employer threshold, if you want group insurance for some employees and an HRA for others, if you want different amounts by class, or if you want to reimburse more than the QSEHRA limits allow.

The eleven permitted classes are set out at 26 CFR 54.9802-4(d)(2), and they are the source of the extra administration: each class needs its own affordability determination.

For most small businesses that do not currently offer group insurance, the QSEHRA is the better starting point. It is simpler, cheaper to administer, and covers the primary use case: helping employees afford individual health insurance.

QSEHRA vs Group Health Insurance

Group health insurance buys you a stronger recruiting pitch. A reimbursement arrangement buys you cost control, no participation minimum, and far less administration.

The practical question for most small business owners is whether the recruiting advantage of group coverage is worth a cost the carrier controls and you do not. For companies competing directly against mid-size employers with full group plans, it can be. Where the labor market is calmer, or where people are spread across several states and want their own plan, the QSEHRA delivers a real benefit on a budget you set.

There is a second, less measurable effect. The absence of any health benefit can take a small business out of a candidate's consideration before salary is ever discussed. A QSEHRA changes "we do not offer benefits" into "we reimburse your premiums tax-free up to a set amount," which is a different conversation in an interview.

QSEHRA Notice Requirements

The QSEHRA notice is a legal requirement under IRC Section 9831(d)(4), and the penalty for skipping it sits in a different part of the code. IRC Section 6652(o) charges $50 per employee per incident of failure, and caps the total for all such failures in a calendar year at $2,500.

Read that cap carefully, because it is the part people get wrong. The $2,500 is the annual maximum for the employer across every failure, not a per-employee figure, and the $50 attaches to the incident rather than to each day the notice is late. On a team of ten, one missed annual notice is $500.

The notice is also an easy rule to miss, for the dull reason that owners who set the arrangement up themselves often never learn it exists. Here is who gets one, when, and what it has to say.

The notice can go out by email. Notice 2017-67 allows electronic delivery when the employer follows the IRS electronic media rules in Treas. Reg. 1.401(a)-21: the employee either affirmatively consents after the required disclosures, or can effectively access the electronic notice and is told a paper copy is available at no charge.

Either route works for a small team that already runs onboarding by email. Adding an e-signature acknowledgment gives you the dated record that the notice actually arrived, which is the evidence you want if a Section 6652(o) question ever comes up.

Here is the notice itself, structured around the three pieces of content the rule requires. Fill in the employee-specific amounts, keep the acknowledgment, and send a fresh copy for each plan year.

How to Set Up a QSEHRA: Step by Step

Eight steps take you from deciding on a QSEHRA to running one, starting with confirming you qualify and ending with year-end reporting.

Setup took me the better part of a working day with an administrator supplying the plan document and the notices, and roughly twice that the first time I did it myself. Self-administration is not harder work; it is more of it, because you source the templates, read the compliance rules, and build the tracking before a single claim arrives.

Administration Options

You have three ways to run the plan day to day: do it yourself, pay for HRA software, or hire a third-party administrator to handle it end to end.

The administration choice comes down to risk tolerance and time. Self-administration costs nothing in fees but asks you to apply the Section 213(d) eligibility rules yourself, keep medical expense records under HIPAA-grade access control, and get the W-2 reporting right. A TPA charges a per-employee monthly fee and absorbs all of that, which is what you are actually buying.

If you are self-administering, this is the workbook that keeps the four things that matter in one place: each employee's permitted benefit, whether the notice went out, whether proof of coverage is on file, and how much of the allowance is left. The last column of the first sheet is the figure you will need at W-2 time.

W-2 Reporting and Compliance

Employers must report the QSEHRA benefit on each employee's W-2 form. The rules differ from how other benefits are reported, starting with which amount goes in the box.

The W-2 mistake to watch for is reporting the amount actually reimbursed instead of the permitted benefit. If an employee's annual allowance is $5,000 and they submitted $3,000 in claims, Box 12 Code FF shows $5,000, not $3,000. The distinction matters because IRC Section 36B(c)(4)(B) reduces the employee's premium tax credit by one twelfth of the permitted benefit for each coverage month.

A lapse in coverage does not change the Box 12 figure either. Under Notice 2017-67, the permitted benefit reported with Code FF stays the same as it would have been had the employee never lost minimum essential coverage; only the taxable amount in Box 1 moves.

QSEHRA and Employee Onboarding

The QSEHRA notice is a Day 1 onboarding task for every new hire who becomes eligible after the plan year has started. Missing it is a Section 6652(o) failure. That makes notice delivery one of the most time-sensitive compliance items in the onboarding process, alongside the I-9, which is due within three business days of the date employment begins.

Only 12% of employees strongly agree their organization does a great job of onboarding new hires, according to Gallup (2018). The QSEHRA notice is one of the places that shows. Handed over as a form, it is paperwork; explained for two minutes, it is the moment a new hire learns the company pays toward their health insurance. Same document, different hire.

Common QSEHRA Mistakes

Here are eight QSEHRA mistakes to design out of your plan from the start, with why each one happens and how to fix it.

The most consequential mistake is the first one: offering a QSEHRA while also offering group health insurance. Under IRS Notice 2017-67, the arrangement then stops qualifying and is treated as an ordinary group health plan, subject to the Section 4980D excise tax of $100 per affected person per day.

Your employees do not pay for that mistake. Properly substantiated reimbursements do not turn into taxable income for them, so the FICA-exempt benefit your team counted on survives, and the cost lands on the business instead.

If you are considering adding a group plan, terminate the QSEHRA before the group plan takes effect, and take the sequencing to a benefits attorney rather than working it out from a blog post.

Frequently Asked Questions