ABC Taxes, Tips & Tools

In gen­eral Group Health insur­ance includ­ing den­tal & qual­i­fied long-term care insur­ance is deductible as a busi­ness expense, but there are very spe­cific issues with respect to small busi­ness own­ers.  A sole pro­pri­etor, part­ner or 2% or more share­holder of an S-corporation can­not deduct more than they earned from self-employment and can­not deduct med­ical insur­ance under self-employment for any time they are cov­ered under any other employer’s plan includ­ing their spouse’s employer.

• Pay­ments made by a part­ner­ship on behalf of a part­ner are deductible as Guar­an­teed Pay­ments to the part­ners, not as med­ical insur­ance expense/employee ben­e­fits.  The part­ner­ship must reim­burse the part­ner if the part­ner pays for the insur­ance in their own name. 
• For 2% share­hold­ers such pay­ments must be included in their wages sub­ject to the usual with­hold­ing taxes. 2% share­hold­ers must be reim­bursed by their S-corporations in order for the insur­ance to be con­sid­ered estab­lished under the busi­ness to qual­ify for the adjustment.
• Self-employed per­sons, AKA Sole Pro­pri­etors, can take the Med­ical Insur­ance Adjust­ment to 1040 Income, whether they pur­chase the insur­ance in their own name or the name of the business. 

How­ever there is a way to obtain med­ical insur­ance for busi­ness owner that is deductible as a busi­ness expense.  Based on Sec­tion 105 of the Inter­nal Rev­enue Code, a small busi­ness owner who can demon­strate employ­able inter­est in the busi­ness can become eli­gi­ble for an employee ben­e­fit pro­gram. All busi­ness fil­ing types are eli­gi­ble includ­ing sole pro­pri­etors, part­ner­ships, C– and S– cor­po­ra­tions. Sec­tion 105 HRA plans are designed specif­i­cally for small busi­ness own­ers that can legit­i­mately hire their spouse. Because the spouse/employee can be reim­bursed for fam­ily expenses the employer indi­rectly ben­e­fits as well. This type of plan is made pos­si­ble by Sec­tion 105 of the Inter­nal Rev­enue Code, Rev­enue Rul­ing 71–588 and IRS Let­ter Rul­ing 9409006. For C-corporation and S-corporation own­ers it will not be nec­es­sary to use the spouse/employee method. The cor­po­ra­tion becomes the employer and the owner is an employee as long as they are an employee receiv­ing a reg­u­lar paycheck.

So you are say­ing, “So what.  If I can take the deduc­tion on my per­sonal tax forms why would I care?”  Whereas it is true that up to 100% of the pay­ments made for health insur­ance maybe deductible on your 1040, which saves on the asso­ci­ated income tax, all those pre­mi­ums will be sub­ject to Self-employment taxes as well.  Under a sec­tion 105 Plan, the amounts paid for the plan pre­mi­ums will not be, a tax sav­ings of 15.3% of those pre­mium costs.  Fur­ther­more out-of-pocket med­ical expenses are only deductible if you item­ize, sub­ject to the 7.5% lim­i­ta­tion of income; under a sec­tion 105 it may be pos­si­ble to write off 100% of out-of-pocket med­ical expenses too. 

Set­ting up a Sec­tion 105 Plan is not a triv­ial exer­cise.  Care must be taken when estab­lish­ing a Sec­tion 105 HRA to ensure that a legit­i­mate employer/employee rela­tion­ship exists with the fam­ily mem­ber. In 1999 the IRS Indus­try Spe­cial­iza­tion Pro­gram issued a paper that said: “The extent and nature of a spouse’s involve­ment in the busi­ness oper­a­tions is crit­i­cal. Although, part-time work does not negate employee sta­tus, the per­for­mance of nom­i­nal or insignif­i­cant ser­vices that have no eco­nomic sub­stance or inde­pen­dent sig­nif­i­cance may be chal­lenged. Merely call­ing a spouse an “employee” is not suf­fi­cient to qual­ify a non-working spouse as an employee”.

If you are going the employee/spouse route, the spouse must pro­vide mean­ing­ful ser­vices to the com­pany, those ser­vices must be nec­es­sary (have eco­nomic sub­stance), and the spouse’s com­pen­sa­tion, which includes the Sec­tion 105 plan, must be rea­son­able. Fur­ther­more it is essen­tial that busi­ness and per­sonal funds not be co-mingled.  e.g. If you hire your spouse to do fil­ing for 4 hours a week and then pay them $10/per hour and pro­vide them with fam­ily med­ical plan cost­ing $800 per month, you can bet the IRS is going to look askance at com­pen­sa­tion which is 82% ben­e­fits and 18% hourly wages.  It prob­a­bly won’t fly. 

How do I estab­lish a sec­tion 105 plan?  If you are a busi­ness owner, you are going to have to hire your spouse.  Really, we are talk­ing the whole employ­ment enchi­lada here. Your busi­ness will need an EIN for pay­roll pur­poses.  You will need an employ­ment appli­ca­tion, w-4, I-9, New Hire paper­work and other items from your spouse, just as you would for any other employee.  You will need to keep a record track­ing hours your spouse worked and a descrip­tion of your spouse’s duties.  You will need to pay rea­son­able com­pen­sa­tion for those duties on a reg­u­lar pay­roll sched­ule.  The house­hold account and the busi­ness account must be sep­a­rate so that pay­checks and reim­bursed med­ical expenses won’t be deposited back into the account they came out of.  Your spouse/employee will need to be the pol­icy holder.  Finally you will need the Sec­tion 105 plan documents. 

In order for a Sec­tion 105 plan to work there are a lot of rules that must be fol­lowed, which is why Art and Busi­ness Con­sult­ing LLC rec­om­mends you get help if you think your busi­ness might qual­ify for a one.  Sec­tion 105 plans are really out­side Art and Busi­ness Con­sult­ing LLC’s baili­wick, although we could cer­tainly advise you on the related tax issues.  So we have found some­one who does do Sec­tion 105 plans.

Art and Busi­ness Con­sult­ing LLC is not affil­i­ated with the fol­low­ing entity, Total Admin­is­tra­tive Ser­vice Cor­po­ra­tion (TASC), but we did meet with Todd Kuehn, Regional Sales Direc­tor–Scotts­dale Region Office TASC  at an Ari­zona Soci­ety of Enrolled Agents event.  TASC’s baili­wick does include Sec­tion 105 Plans; they are a third-party ben­e­fits admin­is­tra­tor based out of Madi­son, Wis­con­sin, can sim­plify com­pli­ance and the admin­is­tra­tive pro­ce­dures asso­ci­ated with Sec­tion 105. Accord­ing to their web­site, TASC has been doing just that for over 30 years with Biz­Plan. They even offer a sav­ings guar­an­tee and a full Audit Guarantee!

For more infor­ma­tion see http://www.tasconline.com/buytasc/affiliate/bizplan/460163769708.  Please note if you click on this link you will be nav­i­gat­ing away from our web­site; you will be sub­ject to their poli­cies and we have no idea what those poli­cies are. Art and Busi­ness Con­sult­ing LLC has not received any gifts or other com­pen­sa­tion for men­tion­ing these folks, and we are not specif­i­cally endors­ing them. 

As always Art and Busi­ness Con­sult­ing is here to help.  If you need help with a small busi­ness and or tax issue, please give us a call.

The usual dis­claimers: Although ABC has made every effort to insure the accu­racy of Taxes, Tips and Tools, mis­in­for­ma­tion, dis­in­for­ma­tion, changes, mis­takes, typos and hack­ers hap­pen, there­fore Art & Busi­ness Con­sult­ing LLC takes no respon­si­bil­ity for any action taken or results based on the infor­ma­tion sup­plied here in. The con­tent of this blog gen­er­ally applies to busi­ness and indi­vid­ual tax­a­tion in the United States of Amer­ica.  Inter­nal Rev­enue Ser­vice Cir­cu­lar 230 Dis­clo­sure:  As pro­vided for in Trea­sury reg­u­la­tions, advice (if any) relat­ing to fed­eral taxes that is con­tained in this com­mu­ni­ca­tion (includ­ing attach­ments) is not intended or writ­ten to be used, and can­not be used for the pur­pose of (1) avoid­ing penal­ties under the Inter­nal Rev­enue Code or (2) pro­mot­ing, mar­ket­ing or rec­om­mend­ing to another party any plan or arrange­ment address herein.  Art & Busi­ness Con­sult­ing LLC cur­rently does not have a cer­ti­fied pub­lic accoun­tant, human resource spe­cial­ist, finan­cial plan advi­sor or an attor­ney on staff; this infor­ma­tion is purely for edu­ca­tional pur­poses and not to be con­strued as legal or finan­cial advice. Art & Busi­ness Con­sult­ing LLC and its employ­ees, mem­bers and asso­ciates are not engage to prac­tice law; you always should dis­cuss legal mat­ters with your attor­ney before talk­ing to any­one else.