Health Insurance Stipends: What Small Employers Need to Know in 2026

In 2013, the regulatory environment around employee health benefits changed, and for most small businesses, that shift arrived without direct notice. As such, many small employers offering a health insurance stipend today are continuing a practice that may no longer be compliant or cost-effective. The good news: the alternatives created in the wake of these changes may be a better fit for your business.

In this article, you'll learn:

• Why informal health insurance reimbursements became so common among small businesses
• How ACA market reforms reclassified these arrangements and created new compliance exposure
• The IRS excise tax risk that can surface during any payroll audit or review
• When a health insurance stipend is and isn't legally safe to offer
• How QSEHRAs and ICHRAs were created to fill the gap left by informal practices

Stipends vs. HRAs: Quick Comparison

Assumes employee is in 22% Federal tax bracket

Why So Many Small Employers Still Use Health Insurance Stipends

For decades, small businesses typically handled employee health costs one of two ways: adding taxable compensation to payroll, or reimbursing premiums directly through a structure that, if properly set up, qualified as an employer accident and health plan under IRC §106, which excluded those contributions from the employee's gross income. [7] Neither approach required significant documentation, and no specific law prohibited either.

The Affordable Care Act changed that. Its market reform requirements, effective 2010, applied broadly to any arrangement classified as a "group health plan" under federal law. [4] Three years later, the IRS issued Notice 2013-54, which clarified that standalone employer payment plans, including premium reimbursement structures that had previously received favorable tax treatment, now fell into that category. [2] 

Because most of these standalone plans could not satisfy ACA requirements, they were now out of compliance. However, in part because guidance was published in federal regulatory channels rather than communicated directly, many small businesses have continued this practice without realizing the rules have changed.

Read More: Why the QSEHRA Exists

The Compliance Risk: IRS Penalties Under IRC §4980D

When an informal reimbursement or earmarked stipend is classified as a non-compliant group health plan, IRC §4980D imposes an excise tax of $100 per day, per affected employee, capped at $36,500 per employee per year [1]. There is no minimum employer size or cap on the total liability that can accumulate.

These excise taxes can be assessed retroactively and do not require a dedicated IRS audit to trigger; a routine payroll review, a Department of Labor inquiry, or an employee complaint can be enough to surface the arrangement.

It is important to note that the IRS has not historically pursued aggressive enforcement against small employers for informal stipend arrangements. That does not eliminate the risk.

Why Taxable Stipends Are Inefficient (Even When Structured Safely)

While an employer can technically offer employees a general wage increase with no instruction on how to spend it, it’s also one of the least efficient ways to help employees pay for health insurance.

When a taxable stipend runs through payroll, the employer owes payroll taxes on top of the stipend amount (the employer's share of FICA alone is 7.65% [3]). The employee also pays ordinary income tax on the full amount received, meaning a significant share of the benefit is lost before it can be used for coverage. In the end, the employer spends more, and the employee receives less real value.

When a Stipend Is Compliant

It’s important to note that stipends are not always bad. There are specific circumstances where a stipend does not create an employer payment plan, and does not trigger the ACA compliance requirements:

Independent contractors: Because contractors are not employees under federal law, an employee health insurance stipend paid to a 1099 worker does not create an employer-sponsored group health plan and is not subject to the same rules that apply to W-2 employees.

General wage increases: An employer can raise taxable wages without designating the funds for health insurance; the key is that the employee must have full discretion over how to spend the money, with no formal or informal requirement to direct it toward coverage.

Excepted benefits: Small supplemental stipends clearly intended for non-primary-health purposes, such as a gym membership or wellness benefit, are generally compliant, as long as they are not structured as a substitute for primary health coverage.

Outside of these specific scenarios, a formal HRA is the only structure that is both fully compliant and tax-efficient for W-2 employees.

A Better Alternative: QSEHRA and ICHRA

In 2016, Congress passed the 21st Century Cures Act, creating the Qualified Small Employer HRA (QSEHRA) effective January 1, 2017, [5] and the Individual Coverage HRA (ICHRA) followed in 2020 under a final federal rule. [6] Both were designed to give employers a structured, compliant path to reimburse employees for individual health insurance: the same goal informal arrangements have always tried to achieve.

Reimbursements through both HRA types are excluded from federal income taxes and FICA taxes for employees, and employer contributions are also deductible as an ordinary business expense. Neither structure requires employers to sponsor a group health plan.

For most small employers who have been offering an informal stipend, either structure will likely deliver more value to employees at a lower net cost to the business. For a detailed side-by-side breakdown, see ICHRA vs. QSEHRA: Which HRA Is Right for Your Business.

Frequently Asked Questions

Is giving employees a stipend always non-compliant?

No. The compliance issue is specific to arrangements where the employer designates funds for health insurance coverage; a general wage increase with no coverage requirement attached is legal, and reimbursements made through a compliant HRA structure such as a QSEHRA or ICHRA would be fully legal and tax-free.

Can I just give employees a raise and let them buy their own insurance?

Yes, with important conditions. The wage increase must have no formal or informal connection to health insurance. Keep in mind that the employee also pays ordinary income tax on the full amount, which reduces the real value delivered compared to a tax-free HRA reimbursement. The employer also pays payroll taxes (FICA) on wages, which they do not pay on HRA reimbursements. A wage increase is more expensive for the employer on a gross basis than an equivalent HRA allowance, even before the employee's tax burden is considered.

What is the difference between a health insurance stipend and an HRA?

A health insurance stipend is a dollar amount added to an employee's paycheck (taxable as income) that the employee uses toward coverage costs, while an HRA is a formal, employer-funded structure that reimburses employees for qualified health expenses, including premiums, on a tax-free basis. QSEHRAs and ICHRAs are IRS-approved HRA types that comply with ACA requirements. To explore both in detail, visit the QSEHRA Learning Center and the ICHRA Learning Center.

The Bottom Line

Many employers still using health insurance stipends today are continuing a practice that was standard before 2010, unaware that the rules have changed around them. QSEHRAs and ICHRAs exist because Congress recognized that gap, and both deliver the same basic outcome: a defined contribution toward employee health costs that is fully compliant (and more tax-efficient) than any informal arrangement.

Last updated: July 24, 2026

Sources

1. 26 U.S. Code §4980D — Failure to Meet Certain Group Health Plan Requirements. Legal Information Institute, Cornell Law School. https://www.law.cornell.edu/uscode/text/26/4980D
2. IRS Notice 2013-54. Internal Revenue Service. https://www.irs.gov/pub/irs-drop/n-13-54.pdf
3. Topic No. 751 — Social Security and Medicare Withholding Rates. Internal Revenue Service. https://www.irs.gov/taxtopics/tc751
4. Affordable Care Act (H.R. 3590), 111th Congress (2010). Congress.gov. https://www.congress.gov/bill/111th-congress/house-bill/3590/text
5. 21st Century Cures Act (H.R. 34), 114th Congress (2016). Congress.gov. https://www.congress.gov/bill/114th-congress/house-bill/34/text
6. Executive Order 13813 — Promoting Healthcare Choice and Competition Across the United States (2017); Final Rule on Individual Coverage HRAs effective 2020. Federal Register. https://www.federalregister.gov/documents/2017/10/17/2017-22677/promoting-healthcare-choice-and-competition-across-the-united-states
7. 26 U.S. Code §106 — Contributions by Employer to Accident and Health Plans. Legal Information Institute, Cornell Law School. https://www.law.cornell.edu/uscode/text/26/106