A Medical Expense Reimbursement Plan (MERP) is an employer-funded health benefit arrangement that reimburses employees, on a tax-free basis, for qualified medical expenses defined under Internal Revenue Code Section 213(d).
It is not health insurance, does not pool medical risk, and does not pay providers directly. Instead, it allows employers to reimburse employees after medical expenses are incurred and properly documented, while keeping employer healthcare costs fixed and predictable.
The Legal and Tax Foundation of a MERP
MERPs are primarily governed by IRS Section 105, which permits employers to reimburse medical expenses without those reimbursements being treated as taxable income to employees.
From a legal standpoint, a MERP is considered a self-insured welfare benefit plan, which means it also falls under ERISA requirements, including the need for a written plan document and defined eligibility rules.
From a tax perspective, the structure is straightforward but powerful. Reimbursements made under a compliant MERP are excluded from employee gross income and are not subject to federal income tax, Social Security tax, or Medicare tax. For employers, reimbursements are deductible as ordinary business expenses.
According to IRS payroll tax data, avoiding FICA taxes alone saves employers 7.65 percent per reimbursed dollar, while employees avoid income tax rates that typically range from 12 to 32 percent, depending on bracket.
How a MERP Actually Works in Practice
A MERP operates strictly on a reimbursement basis. Employers do not pre-fund individual accounts, and employees do not receive cash allowances.
The employer defines a maximum reimbursement amount, usually monthly or annually, and reimburses only verified expenses.
The typical operational flow involves the employee paying for a medical expense, submitting documentation such as an Explanation of Benefits or receipt, and receiving reimbursement from the employer after verification.
If no expense is submitted, no money is paid. Unused amounts remain with the employer and do not roll over to employees as cash or benefits.
This structure is one reason MERPs are favored by cost-conscious employers. Industry administrators report that average utilization rates range between 60 and 70 percent, meaning employers only pay out a portion of their theoretical maximum exposure.
Eligible Expenses Under a MERP
MERPs reimburse expenses defined under IRC Section 213(d), which covers a broad range of medical costs.
According to the Bureau of Labor Statistics Consumer Expenditure Survey, U.S. households spend an average of $5,177 per year on healthcare, with the majority falling into Section 213(d) eligibility.
Common Reimbursable Expenses
Expense Category
Eligible Under MERP
Notes
Health insurance premiums
Yes
Individual and employer-sponsored
Deductibles and copays
Yes
Includes HDHP deductibles
Prescription drugs
Yes
Excludes cosmetic medications
Mental health services
Yes
Therapy and psychiatry covered
Dental care
Yes
Preventive and restorative
Vision care
Yes
Exams, lenses, contacts
Diagnostic testing
Yes
Labs, imaging, screenings
Over 75 percent of out-of-pocket healthcare spending for insured Americans qualifies under Section 213(d), making MERPs broadly applicable to real-world medical costs.
MERP vs Traditional Health Insurance
A MERP does not function like insurance and should not be evaluated as a replacement for major medical coverage.
Insurance spreads risk across a population and pays providers directly. A MERP reimburses expenses after the fact and does not cap catastrophic medical exposure on its own.
Structural Comparison
Feature
MERP
Traditional Group Insurance
Risk pooling
No
Yes
Premiums
None
Required
Employer cost predictability
High
Low
Claims paid directly to providers
No
Yes
Catastrophic coverage
No
Yes
Regulatory complexity
Moderate
High
Because of these differences, MERPs are often paired with individual insurance policies or high-deductible group plans to balance cost control with financial protection.
Why Employers Use MERPs Instead of Expanding Insurance
Employer-sponsored health insurance costs have risen steadily for over two decades.
According to the Kaiser Family Foundation 2024 Employer Health Benefits Survey, average annual premiums reached $8,435 for single coverage and $23,968 for family coverage, with employers covering roughly 73 percent of those costs.
MERPs allow employers to replace unpredictable premium increases with fixed reimbursement limits.
Cost Predictability Example
For small and mid-sized businesses, this difference often determines whether a health benefit is sustainable at all.
MERPs and Small Business Adoption Trends
MERPs are most commonly adopted by employers with fewer than 50 full-time employees, particularly those not subject to the Affordable Care Act employer mandate.
Data from third-party benefit administrators indicates that small employers using reimbursement-based benefits save between 20 and 40 percent annually compared to traditional group plans.
This trend accelerated after 2020 as premium volatility increased and workforce structures became more flexible. Employers with mixed full-time, part-time, and contract staff often prefer MERPs because eligibility rules can be defined without renegotiating insurance contracts.
Compliance and Administrative Requirements
Despite their simplicity, MERPs are not informal arrangements. To remain compliant, employers must maintain a written plan document, define eligibility and reimbursement limits, and follow HIPAA privacy rules when handling medical information.
Core Compliance Elements
Requirement
Purpose
Written plan document
ERISA compliance
Defined eligibility rules
Nondiscrimination
Substantiation of expenses
IRS compliance
HIPAA safeguards
Employee privacy
Formal reimbursement process
Audit protection
Improperly structured plans can result in reimbursements being reclassified as taxable income, along with potential penalties. For this reason, most employers rely on third-party administrators rather than handling claims internally.
MERP vs Other Reimbursement-Based Benefits
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MERPs are often confused with HRAs and FSAs, but the distinctions matter legally and operationally.
Detailed Comparison
Feature
MERP
HRA
FSA
Employer funded
Yes
Yes
Partially
Employee contributions
No
No
Yes
Subject to use-it-or-lose-it
Yes
Yes
Yes
Requires insurance
Often
Often
Yes
Cash-out allowed
No
No
No
ACA integration
Limited
High
Moderate
MERPs tend to be simpler than HRAs but offer less flexibility in large, ACA-regulated environments.
Limitations and Risks of MERPs
MERPs are not suitable for every workforce. Employees must be able to pay medical expenses upfront and wait for reimbursement.
For workers with chronic conditions or high ongoing costs, reimbursement delays can create cash flow pressure. Additionally, MERPs do not protect against catastrophic claims unless paired with insurance.
From the employer side, nondiscrimination rules require careful plan design to avoid favoring highly compensated employees disproportionately.
Bottom Line
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A Medical Expense Reimbursement Plan is a legally defined, tax-advantaged reimbursement structure that allows employers to pay for real medical expenses without assuming the open-ended cost exposure of traditional health insurance.
Its value lies in predictability, tax efficiency, and controlled liability, not in risk pooling or comprehensive coverage.
When properly designed and paired with insurance, a MERP can serve as a stable middle ground between offering no health benefit at all and absorbing the escalating costs of full group coverage.
