What is a MERP?
MERP stands for Medical Expense Reimbursement Plan and is any plan or arrangement under which a business reimburses an employee for out-of-pocket medical expenses incurred by employees or their dependents. If administered correctly, all reimbursements are paid to the employee 100% tax-free. A MERP is not a Section 125 Plan, Cafeteria Plan, or Flexible Spending Account. Rather, it is a Section 105 Plan.
How Does a MERP Work?
A MERP is essentially a business expense account for healthcare - employees need to turn in receipts to get reimbursed. These receipts are required to be stored for up to 7 years for IRS auditing purposes. The IRS will not allow tax deductions via a MERP if the expenses were not qualified medical expenses.
A business must set up a MERP (it cannot be set up by an individual). During plan set up, the business decides what types of medical expenses to reimburse.
A MERP is extremely flexible and can reimburse nearly every medical expense an employee may have.
What Medical Expenses Can a MERP Reimburse?
A MERP can reimburse any expense considered to be a qualified medical expense by the IRS, including premiums for individual health insurance policies. Note that businesses may restrict the list of reimbursable expenses in any way they choose.
Some common categories of reimbursable items include:
1. Health Insurance Premiums
2. Doctor Visits
7. Over the Counter Drugs (Prescription required)
For more information, see IRS Publication 502.
Do You Need Health Insurance to Participate in a MERP?
While many businesses use a MERP to reimburse employees for the cost of their individual health insurance coverage, an employee is not required to have health insurance in order to participate in a MERP. MERPs can also be used in conjunction with health savings accounts (HSAs) and flexible spending accounts (FSAs).
Why Would a Business Offer a MERP?
There are two reasons a business would offer a MERP:
A MERP Can Reimburse Employees' Out-of-Pocket Health Insurance Premiums
A MERP Allows Employers to Self-Insure Group Health Plan Deductibles
A MERP is a form of self-insurance. An employer can use a MERP as a way to lower medical insurance costs but still cover the employees’ qualified medical expenses tax-free. In a year when the cumulative medical costs for employees are relatively low, the savings on insurance costs can be quite significant.
For example, if a business reduces medical insurance coverage in order to lower premiums without adding a MERP, that employer is simply shifting medical expenses from employer to employee. In addition, the employee could then be forced to pay their higher medical expense using after-tax funds. The MERP helps avoid that added cost to the employee.
A MERP helps defray the cost of medical expenses. It also helps the employer save money on taxes. Like a health savings account, funds in a MERP can roll over from year to year. The employer decides the amount that rolls over. Unlike a health savings account, only employers can contribute funds to MERPs. The funds cannot come out of an employee's salary, voluntarily or involuntarily. There is no limit on the amount of funds an employer can put into a MERP.
Note: This should not be taken as legal or tax advice.