QSEHRA and ICHRA: the small employer health benefit alternatives to group insurance, the 2026 contribution limits, and the ACA market reform compliance framework

For small businesses, providing health benefits to employees has been an expensive proposition. Traditional group health insurance has minimum participation requirements (typically 70% of eligible employees must enroll), substantial administrative costs, and rates that don't scale favorably for businesses with fewer than 50 employees. Many small businesses simply don't offer health benefits at all, which limits their ability to attract and retain employees in a competitive labor market.

The Health Reimbursement Arrangement (HRA) framework provides an alternative. Two specific HRA variants are designed for small employers: the Qualified Small Employer Health Reimbursement Arrangement (QSEHRA) and the Individual Coverage HRA (ICHRA). Both allow employers to provide tax-advantaged health benefits without offering traditional group insurance, and both work in coordination with the individual market for health insurance.

The framework is operationally straightforward but technically demanding. Several specific compliance requirements (offer rules, notice requirements, coordination with the ACA market reforms) have to be met for the arrangement to qualify for tax-favored treatment. Failures produce significant penalty exposure, including the §4980D excise tax at $100 per employee per day for non-compliant standalone HRAs.

What HRAs were before 2017

Historically, HRAs were widely used by small employers as standalone health benefits. The employer would set up an HRA, fund it with a defined amount per employee, and let employees use the funds for medical expenses and (sometimes) health insurance premiums purchased in the individual market.

The Affordable Care Act's market reforms (effective 2014) created a problem. ACA prohibited annual and lifetime dollar limits on essential health benefits and required certain preventive services to be covered without cost-sharing. Standalone HRAs by their nature have dollar limits (the employer's defined contribution). The IRS interpretation, in Notice 2013-54, was that standalone HRAs were group health plans subject to ACA market reforms, and the dollar-limit prohibition made them effectively non-compliant.

The result was that standalone HRAs essentially went away for employees not covered by another group plan. Standalone HRAs that violated the ACA framework were subject to the §4980D excise tax at $100 per employee per day. Most small employers had to either offer traditional group insurance, give employees taxable wages, or simply not provide health benefits at all.

QSEHRA: the 21st Century Cures Act fix for small employers

The 21st Century Cures Act, signed into law December 13, 2016, created the QSEHRA framework specifically to restore standalone HRA availability for small employers. The statutory authority is at IRC §9831(d), and the operational requirements are in IRS guidance under Notice 2017-67.

To qualify as a QSEHRA, the arrangement must meet all of the following requirements:

The employer must not be an Applicable Large Employer (ALE). ALE status under §4980H applies to employers with 50 or more full-time equivalent employees during the prior calendar year. QSEHRA eligibility ends if the employer crosses the ALE threshold.

The employer must not offer a group health plan to any of its employees. QSEHRA cannot be combined with group insurance for any segment of the workforce. If the employer offers group insurance to executives but wants to use QSEHRA for the broader workforce, the arrangement fails.

The QSEHRA must be offered to all eligible employees on the same terms. "Eligible employees" can exclude certain categories specified in §9831(d)(3): employees under 25, part-time employees, seasonal employees, employees covered by a collective bargaining agreement, and certain non-resident aliens. But within the eligible category, all employees must be offered the QSEHRA on the same terms.

Annual contribution limits apply. For 2026, the limits per Rev. Proc. 2025-32 (released October 9, 2025) are:

$6,450 per year for self-only coverage ($537.50 per month).

$13,100 per year for family coverage ($1,091.66 per month).

These limits are subject to annual inflation adjustment using the chained Consumer Price Index (C-CPI), which generally produces smaller upward adjustments than the regular CPI. The 2026 limits are a $100 (1.57%) increase over the 2025 limits of $6,350 self-only and $12,800 family.

Reimbursements must be for §213(d) medical expenses. IRC §213(d) defines qualified medical expenses broadly to include premiums, deductibles, copayments, prescriptions, and most other medical costs. QSEHRA can reimburse individual health insurance premiums (including ACA marketplace plans) as well as other §213(d) expenses.

Employees must have minimum essential coverage (MEC). Per §9831(d)(2)(B), the employee must be enrolled in MEC to receive tax-free QSEHRA reimbursements. Without MEC, the reimbursements are subject to ordinary income tax.

90-day advance written notice. The QSEHRA must be in place and employees must receive written notice of the arrangement at least 90 days before the start of the plan year (or, for new employees, within 90 days of becoming eligible). The notice must include specific content per §9831(d)(4): the maximum benefit amount, the requirement to maintain MEC, the federal income tax consequences if the employee doesn't have MEC, and other required disclosures.

ICHRA: the broader-reach framework

The Individual Coverage HRA (ICHRA) was created by the Trump administration's June 2019 final rule under 29 C.F.R. §2590.702-2 and parallel IRS and Treasury regulations. It's broader in scope than QSEHRA:

No employer size limit. ICHRA is available to employers of any size, including ALEs.

No contribution cap. ICHRA can be funded at any level the employer chooses.

Class-based offers. Employers can offer ICHRA to specific classes of employees (full-time, part-time, salaried vs. hourly, employees by geographic location, etc.) and offer different classes different benefits. Class-based offers are limited to specific categories defined in the regulations and subject to minimum class size requirements.

Coordination with §4980H employer mandate. ICHRA can satisfy the ACA's employer mandate for ALEs if the contribution is sufficient to make individual coverage "affordable" under specified affordability tests. For ALEs (50+ FTE employers), ICHRA is an alternative compliance path to traditional group insurance.

The flexibility of ICHRA comes with more complex compliance requirements. The notice and election rules are detailed, the class-based offer rules require careful documentation, and the affordability tests for ALEs require specific calculations. For most small employers, QSEHRA is the simpler framework; ICHRA is more useful for mid-size businesses, larger employers, and employers wanting variable benefits across employee classes.

How QSEHRA actually works operationally

A typical QSEHRA implementation:

The employer sets up the QSEHRA plan document, identifies the contribution amount (up to the annual limits), and confirms eligibility rules.

The employer provides 90-day advance written notice to all eligible employees.

Eligible employees enroll in individual health insurance coverage. The ACA marketplace is one option; off-marketplace individual insurance is another. The employee must enroll in MEC.

The employee pays the premium and incurs other §213(d) medical expenses. The employee submits documentation (receipts, premium notices, EOBs) to the employer or HRA administrator.

The employer reimburses up to the contribution limit, tax-free to the employee and tax-deductible to the employer.

Several operational considerations:

QSEHRA can be administered in-house but most small employers use third-party administrators (TPAs) that handle the substantiation, reimbursement processing, and documentation. TPA fees typically run $30-$80 per employee per month.

The Special Enrollment Period (SEP) on the ACA marketplace is available to new QSEHRA recipients. Employees with QSEHRA coverage can enroll in individual marketplace plans outside of Open Enrollment if they qualify for the QSEHRA SEP.

QSEHRA contributions affect ACA marketplace premium tax credit eligibility. The employee's premium tax credit is reduced (potentially to zero) based on the QSEHRA contribution amount; the IRS has specific affordability tests that determine whether the employee still qualifies for premium tax credits.

Unused QSEHRA contributions can roll over to the next year at the employer's option. The annual contribution limit still applies to total funds available to the employee in any year.

When QSEHRA is and isn't a fit

QSEHRA is well-suited for:

Small employers (fewer than 50 FTEs) who currently offer no health benefits and want to provide a meaningful benefit at predictable cost.

Small employers whose employees are spread across multiple geographic markets where group insurance would have different rate structures for each.

Small employers with employees who already have spouse/parent coverage and would not enroll in group insurance anyway.

Small employers who want budget predictability over the traditional 70% enrollment rate uncertainty of group insurance.

QSEHRA is less well-suited for:

Employers expecting growth across the 50-FTE ALE threshold (the QSEHRA framework ends at ALE status).

Employers in high-premium markets where the QSEHRA limit ($6,450 self / $13,100 family for 2026) doesn't cover meaningful individual coverage. In high-cost markets like California's individual market, the QSEHRA limit may purchase only catastrophic-level coverage; ICHRA's unlimited contribution may be a better fit.

Employers wanting differentiated benefits across employee classes (executive vs. general workforce). ICHRA is the appropriate framework; QSEHRA's same-terms-for-all-eligible requirement does not allow class-based differentiation.

Employers whose employees are heavily concentrated in a single geographic market where traditional group insurance rates are competitive.

The interaction with ACA premium tax credits

A QSEHRA contribution affects the employee's eligibility for ACA premium tax credits in a way that's important to understand:

Per §36B(c)(4), employees who are eligible for QSEHRA are still eligible for premium tax credits, but the credit is reduced by the lesser of:

(1) The QSEHRA contribution allowed for that employee.

(2) The amount that would make the QSEHRA contribution exceed 9.78% of the employee's household income (the ACA affordability threshold).

The practical effect: for lower-income employees in markets with substantial ACA marketplace subsidies, the QSEHRA contribution may functionally replace the subsidy. For middle-income employees who don't qualify for substantial subsidies, the QSEHRA provides a true incremental benefit. For higher-income employees, the QSEHRA is the primary or only employer health benefit and the affordability analysis doesn't materially affect the value.

Employers offering QSEHRA should help employees understand the interaction with marketplace subsidies. The QSEHRA notice required under §9831(d)(4) includes some of this information, but employees often need additional guidance to make informed coverage decisions.

The §4980D penalty for non-compliance

The §4980D excise tax is $100 per employee per day for non-compliant group health plans, with maximum annual exposure of $36,500 per employee. For a small employer with 10 employees and a 6-month period of non-compliance, the exposure can be $1.8 million in excise tax alone, before considering any unpaid back income tax on the impermissible reimbursements.

Common §4980D triggers in the QSEHRA context:

Failing to provide the 90-day advance written notice with required content.

Offering the QSEHRA to employees while also offering group health coverage (the no-group-plan requirement).

Crossing the ALE threshold without terminating the QSEHRA.

Making reimbursements to employees without verifying their MEC enrollment.

Exceeding the annual contribution limits.

Excluding employees who don't fit one of the §9831(d)(3) permitted exclusion categories.

The compliance requirements are detailed but not impossible. Small employers using a TPA generally have the administrative framework to meet the requirements; direct administration without a TPA puts more responsibility on the employer and creates more exposure to compliance failures.

How QSEHRA / ICHRA fits with other small business benefits

The HRA framework coordinates with several other small business compensation tools covered in the Halstonberg pillar:

§125 cafeteria plans can include health flexible spending accounts (FSAs) but cannot include QSEHRA. The two frameworks don't combine.

§401(k) and qualified retirement plans are separate from QSEHRA and can be offered alongside it.

§199A QBI deduction treats QSEHRA contributions as deductible business expenses that reduce QBI. For sole proprietors and pass-through entities, the QSEHRA contribution reduces both ordinary income and QBI in proportion.

S corporation reasonable compensation interacts with QSEHRA: 2%+ S corp shareholders are treated as self-employed for HRA purposes and generally cannot participate in QSEHRA on a tax-favored basis. The HRA framework treats 2%+ owners as employees for some purposes but as self-employed for tax-favored medical reimbursement purposes.

Practical guidance

For small businesses considering health benefits:

Run the cost comparison. QSEHRA with a TPA typically costs $3,000-$7,000 per year in administration plus the contribution amounts ($6,450 per single employee, $13,100 per family). Compare this to the cost of traditional group insurance for the same workforce. For small businesses where group insurance is expensive due to demographics or geographic factors, QSEHRA is often substantially cheaper.

Confirm ALE status. Track full-time equivalent employee counts; QSEHRA eligibility ends if you cross 50 FTE. Plan for the transition (typically to ICHRA) before crossing the threshold.

Document the 90-day notice carefully. The notice content requirements under §9831(d)(4) are specific; using a TPA's compliant notice template reduces the risk of a procedural defect.

Communicate the marketplace subsidy interaction to employees. Employees need to understand how the QSEHRA affects their premium tax credit eligibility.

For multi-class workforces, consider ICHRA instead. The class-based offer flexibility under ICHRA is worth the additional compliance complexity for employers with materially different employee categories.

For S corporation owners, the QSEHRA framework doesn't provide tax-favored medical reimbursement; alternative approaches (S corp medical reimbursement, individual coverage outside of HRA) may be more useful.

The QSEHRA framework is well-established and operationally straightforward. The IRS guidance is clear, the TPA market is mature, and the cost savings vs. traditional group insurance can be substantial for small employers. The compliance requirements are detailed but achievable; the §4980D penalty exposure is significant but avoidable with proper administration.