Technical Tax & Compliance Framework

This page is intended for CPAs, benefits professionals, brokers, HR leadership and counsel who want to understand the federal tax architecture underlying ESPA.

ESPA uses two separately defined employer medical benefits with distinct funding and tax functions: an Employer-Sponsored Medical Benefit elected through the employer’s Section 125 cafeteria plan, and a separately employer-funded Self-Insured Medical Reimbursement Plan.

For a plain-English overview, see The ESPA Tax Structure, Explained Simply. Nothing on this page is tax or legal advice. Your advisors are welcome to review the plan documents directly.

Authority Table

Authority	Role in ESPA
IRC §213(d)	Defines qualifying medical care.
IRC §106	Addresses exclusion of employer-provided accident or health coverage.
IRC §125	Permits eligible employees to elect qualified benefits instead of taxable compensation through a written cafeteria plan.
IRC §105(b)	Addresses exclusion of qualifying employer-plan medical reimbursements.
IRC §105(h)	Applies nondiscrimination requirements to self-insured medical reimbursement plans.
IRC §125 nondiscrimination rules	Apply separately to the cafeteria plan.
IRC §§3121, 3306 and 3401	Address applicable employment-tax and withholding treatment.

The 2007 proposed cafeteria-plan regulations provide additional interpretive guidance regarding employee salary-reduction elections and the employee share of employer-provided qualified benefits. Those regulations remain proposed rather than final.

The IRS’s 2007 proposed rules expressly describe employer-provided accident and health coverage as a cafeteria-plan qualified benefit and define a premium-only plan around an employee share of employer-provided accident and health coverage excludable under §106.

Two coordinated medical benefit components

Employer-Sponsored Medical Benefit, Component One in the Plan documents

The employer establishes an accident or health benefit consisting of defined qualifying §213(d) medical services. The benefit has an objectively determined standalone cost under a documented benefits-cost methodology. The employer establishes an Employee Share that does not exceed the applicable cost of the benefit. An eligible employee may prospectively satisfy that Employee Share through the employer’s written §125 cafeteria plan. Section 106 addresses the exclusion applicable to employer-provided accident or health coverage.

Employer-Funded SIMRP, Component Two in the Plan documents

The SIMRP is separately funded by the employer. It may provide qualifying medical services and reimbursement of eligible qualifying §213(d) medical expenses under §105(b), subject to Plan eligibility, medical-expense, coordination and reimbursement requirements. The employee’s Section 125 election is not allocated to the SIMRP. A reimbursement is payable only for eligible medical expense actually incurred and not already paid or reimbursed from another source, up to the Plan’s maximum. The maximum is a limit, not an amount every participant receives. An independent third-party administrator applies the SIMRP’s eligibility, participation, medical-expense, coordination and reimbursement procedures.

Why the funding separation matters

Notice 2002-45 and Rev. Rul. 2002-41 provide an important analytical framework for arrangements in which salary-reduction-funded accident or health coverage operates alongside a separately employer-funded medical reimbursement arrangement.

ESPA applies that framework by maintaining an independently determined cost for the Employer-Sponsored Medical Benefit, allocating the employee’s Section 125 election to that benefit, separately employer funding the SIMRP, and administering the SIMRP reimbursement under its own medical-expense requirements.

Rev. Rul. 2002-41 specifically found the reimbursement arrangement was not attributable to salary reduction where the salary-reduction election was used only for the separate major-medical coverage and did not exceed its actual cost.

Relationship to Rev. Rul. 2002-3

ESPA does not treat the employee’s Section 125 election as a medical expense available for a second tax-free reimbursement. The election satisfies the Employee Share of the Employer-Sponsored Medical Benefit. The employer separately funds the SIMRP for separate eligible medical expenses.

Participation

Medical participation may satisfy a Plan condition. Participation itself does not replace the medical-expense requirement applicable to a §105(b) reimbursement.

How the ESPA works alongside major medical

The ESPA is designed to operate alongside the employer’s existing group medical coverage. It is not major medical insurance and does not include fixed indemnity products. Group health plan requirements that apply to each component are addressed separately in the plan documents.

Nondiscrimination

Section 125 and Section 105(h) nondiscrimination requirements apply to the ESPA. Eligibility and benefits are reviewed against those requirements as part of plan setup and administration.