Medical Expense Reimbursement Plan: A Tax-Smart Employer Guide

With healthcare costs rising every year, many employers are turning to a medical expense reimbursement plan as a flexible, tax-advantaged way to support employee health expenses. In the following article, we’ll cover what a MERP is, how it works, and the most common types — including newer options like the ICHRA that didn’t exist a few years ago.

What Is a Medical Expense Reimbursement Plan?

A medical expense reimbursement plan (MERP) is a pre-defined allowance of tax-free money employers offer employees to pay for eligible medical, dental, and vision expenses. The employer sets the rules. The employee uses the funds for qualified care. Both sides get a tax benefit.

The IRS publishes the full rules in Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans. As a result, MERPs are tightly regulated — but the rules also make them powerful when used correctly.

MERPs Offered Alongside Group Health Insurance

One common setup is to offer a MERP alongside group health insurance. Employers often pair a MERP with a high-deductible health plan (HDHP). The MERP reimburses employees for part of the deductible using pre-tax dollars. As a result, both the employer and the employee save money.

MERPs paired with group insurance are often called Group Coverage HRAs (GCHRAs), integrated HRAs, or deductible HRAs.

MERPs Offered as a Stand-Alone Benefit

A MERP can also stand alone, replacing traditional group health insurance entirely. In this setup, the employer reimburses employees for individual health insurance premiums and other qualified medical expenses. Two specific stand-alone options matter most for small businesses:

QSEHRA (Qualified Small Employer HRA). Available to businesses with fewer than 50 full-time equivalent employees. It has annual contribution limits set by the IRS — for 2025, the cap is approximately $6,350 for self-only and $12,800 for family coverage (the IRS adjusts these annually). See our FTE calculation guide if you’re near the 50-employee threshold.

ICHRA (Individual Coverage HRA). Available to businesses of any size. The ICHRA was created by federal regulations in 2019 and became effective January 2020. It allows employers to reimburse employees for individual health insurance premiums and qualified medical expenses without a contribution cap. The HealthCare.gov ICHRA overview walks through the eligibility rules.

MERPs for Specific Categories of Care

In addition, a MERP can be tailored to specific categories of care — vision, dental, or other narrow types of expenses. For example, an employer might offer traditional group health insurance for medical needs and use a separate MERP just for dental and vision.

The employer decides which expenses qualify for reimbursement, subject to IRS rules.

How a Medical Expense Reimbursement Plan Works

Using a MERP follows a straightforward, five-step process for both employers and employees:

1. Set the allowance. The employer chooses a monthly allowance — the maximum amount employees can be reimbursed each month.
2. Employee makes qualified purchases. The employee pays for eligible medical, dental, or vision expenses for themselves or their family.
3. Employee submits proof of purchase. Typically a receipt or Explanation of Benefits (EOB). Documentation must include the date, amount, employee name, and a description of the service or product.
4. Employer reviews and reimburses. The employer verifies the claim meets MERP eligibility rules and issues the tax-free reimbursement.
5. Employer reports the reimbursements. Accurate reporting keeps you compliant with IRS guidelines and your books clean.

Most MERP administrators offer software that handles documentation, eligibility checks, and reporting automatically. As a result, the administrative lift is much smaller than it used to be.

Why Use a Medical Expense Reimbursement Plan?

A MERP offers several real advantages for a childcare business or any small employer.

Tax Savings on Both Sides

Reimbursements to employees are tax-free. Meanwhile, the employer’s contributions are tax-deductible business expenses once paid out. For more on the tax side, see our guides to the childcare health insurance credit and the top 10 tax deductions for childcare businesses.

Employer Control

The employer designs the plan to fit the business. You choose the monthly allowance. You decide which categories of expense qualify. You decide whether the MERP supplements group insurance or replaces it. SHRM’s benefits resources can help you benchmark what other small employers offer.

Employee Flexibility

A MERP gives employees real flexibility. They can use the funds for deductibles, copays, prescriptions, dental work, vision care, and many other qualified expenses. As a result, the benefit feels meaningful — not one-size-fits-all.

Fits Businesses That Can’t Afford Group Coverage

For many small childcare businesses, traditional group health insurance is simply unaffordable. A QSEHRA or ICHRA gives you a way to offer a real, tax-advantaged health benefit at a manageable cost — without the volatility of group insurance renewals.

Is a MERP Right for Your Childcare Business?

The right answer depends on your size, your team, and your goals. A few questions to consider:

• How many full-time-equivalent employees do you have?
• Are you currently offering group health insurance, or nothing at all?
• Do your employees value flexibility (covering individual plans, dental, vision) or predictability (one group plan)?
• Are you near the 50-FTE Affordable Care Act threshold?
• How does this fit your business structure and tax position?

Each MERP type has its own rules, paperwork, and limits. As a result, working with a CPA before you launch saves a lot of cleanup later.

Get Tax-Smart Help With Employee Benefits

Have questions about which tax strategies can save you and your employees money? Reach out to the experts at Honest Buck. We’ll help you decide which health savings tools and tax-advantaged employee benefits are right for your Early Childhood Education business. Contact us today.