[Editor's Note: This is a guest post from Jim Adkinson, CPA, an accountant in Orlando, FL. We have no financial relationship but I'm sure he'd love to help you see if a Section 105 plan is right for you and he is more than willing to answer questions by email at [email protected].
By way of introduction, a Health Reimbursement Arrangement/Account (i.e. HRA) is one type of a Section 105 plan. These are generally used by an employer who wishes to go to a high-deductible health plan in order to save money on the premiums, but doesn't wish to pass that high-deductible on to his employees. So perhaps he buys a plan with a $5000 deductible, but the HRA covers everything from $1000 to $5000, so the employee only “feels” a $1000 deductible. My business partnership uses this for its employees (but not the partners.) This post is about figuring out a way to use this particular loophole for the business owner(s).]
Jim Adkinson, CPA
Did you know that you can legally write your kid's braces off as a business expense? It is true. If properly established, a Section 105 Plan can allow you to do exactly that– write off your kids braces, as well as other legitimate medical expenses.
Section 105 Plan
The Section 105 Plan is an “employee” benefit plan. This means someone needs to qualify as an employee. The problem is if you run your business as a sole proprietorship (which includes a single member LLC), a partnership, or an S-Corporation, you are deemed “self-employed.” As “self-employed,” you cannot get the benefits from the plan. So you have to figure out another way to qualify. Here are some examples:
- If you are a sole proprietor (or single-member LLC taxed as a proprietorship) and you are married, you can hire your spouse.
- If you are a partner in a partnership (or LLC taxed as a partnership), you can hire your spouse so long as they do not own more than 5% of the business.
- If you are a shareholder member in an entity taxed as an S-Corporation, you do not qualify, and your spouse does not either. Your best bet in that situation is to segregate part of your income into a separate entity, such as a sole proprietorship or a C-Corporation, and run the plan through that entity.
- Finally, if you run your business – or even just a fraction of your overall business – as an entity taxed as a C-Corporation, you do qualify as an employee all by yourself.
The Fine Print
As with most IRS provisions, this is not without fine print. For instance, the plan has to cover all eligible employees. You cannot just cover yourself and your family and exclude everyone else. However, there are several “safe harbors” that can be used to limit coverage.
Specifically, you can exclude:
- Employees under age 25
- Employees working less than 35 hours a week
- Employees working less than nine months per year
- Employees who have worked fewer than three years
How It Works
Once you qualify, the plan lets you reimburse your employee for all the medical expenses they incur for themselves, their spouse, and their dependents. Basically, the plan allows you to take what most likely would have been a nondeductible personal expense and convert it to a business expense. Medical expenses are typically deducted on Schedule A and are limited by the 10% floor which means you must have medical expenses in excess of 10% of your adjusted gross income before you are allowed to deduct anything. Not only do you save federal and state income tax, but also payroll taxes of up to 15.3% [less for most docs-ed.]
What Is Deductible?
The following expenses are deductible using a Section 105 Plan:
- Major medical insurance, long-term care coverage, Medicare part B and D coverage, and Medigap insurance
- Co-pays, deductibles, and prescriptions
- Dental, vision, and chiropractic care
- Big ticket items like braces for your kid's teeth, Lasix surgery for your eyes, fertility treatments, and special schools for learning-disabled children
- You can even reimburse for over-the-counter medications, vitamins, and herbal supplements, and medical supplies, as long as they are prescribed by physician
The best part is that this is money you would spend anyway, whether you deducted it or not. You are just moving it from a nondeductible or partially deductible place in your return to a deductible place.
Setting It Up
To set up a Section 105 Plan, you will need a written plan document, which can be provided by a number of firms. You need to make sure the benefits you pay correlate to a reasonable compensation for the work your employee does. You need to verify the work employee does to establish the benefits you pay are reasonable. Finally, you need to establish a paper trail to verify payment.
What do you think? Does your business already use a Section 105 plan of some type? Would you consider adding one to your business?
We are a C corp 10-12 owners, hires around 45 people. So the business will pay all the employees and owners for the expense. hmmmm probably not worth it. Now if uncle Sam was letting them take deductions…..
Can you still contribute to an HSA if you have a Section 105 plan?
I don’t think given the affordable care act that a Sec 105(b) plan works unless you have only a single employee (yourself) or only yourself and your spouse.
Whitecoatinvestor: Please feel free to delete this link, no hurt feelings on my end, but here’s my blog post on what small businesses need to know. The main point is that even if you don’t have to provide healthcare, I think once you provide healthcare, you need to comply with ACA.
http://evergreensmallbusiness.com/10-obamacare-facts-small-business-owners-must-know/
I would also recommend caution given the penalties that run $36,500 per employee.
Unless you already have this in place, it would more likely be better to just negotiate with the Dentist. Offer to pay it all up front in cash and you can get 10-25% off every time. Saves the doctor processing fees, billing, collections etc. Granted you may be able to do both, but filing another tax return will negate some of those savings.