We are recommending using a Section 105 Medical Expense Reimbursement Plan to write off family medical bills as business expenses. I'm writing today to explain exactly how it works so you can implement it in 2009 if you so desire.
Section 105 plans let employers, including sole proprietors, partnerships, S-corps, and C-corps, to reimburse their employees, their employees' spouses, and their employees' dependents for uninsured medical costs. Plan benefits are deductible by the business, and nontaxable to the employee. Let's assume you want to establish a plan for your business.
Here's how it works:
* You have to establish the plan for employees. If you're taxed as a sole proprietor, partner, or S-corp, you're considered "self-employed' and not eligible. If you're married, the easiest and most common scenario is to hire your spouse and pay benefits through them. (If you're taxed as a partner, you can hire your spouse provided they own no more than 10% of the business. If you operate as an S-corp, you and your spouse are both considered self-employed. In that case, segregate part of your income through a proprietorship or C-corp and pay benefits through that entity.)
* You can't discriminate in favor of highly compensated employees. However, you can use a classification test (such as "all participants in Employer's group health plan") to qualify participants. You can also exclude those under age 25; those who regularly work less than 35 hours per week; those who work less than nine months out of the year; and those who have worked for you for less than three years. (These limits are spelled out in Treasury regulations.)
* You can deduct 100% of your employees' health insurance. Deductible health insurance costs include major medical and supplemental premiums, Medicare premiums, qualified long-term care premiums, and Medicare supplemental ('Medigap') policies.
Out-of-pocket medical costs include routine expenses such as co-pays, deductibles, and prescriptions; occasional expenses such as eyeglasses and dentistry; big-ticket items like orthodontics, fertility treatments, and schools for learning-disabled children. It also includes nonprescription medicines and health-care supplies. You can reimburse employees or pay health-care providers directly.
You'll need a written plan document and summary plan description to establish the plan. No special filings are required until the plan covers 100 or more employees. Report these benefits as "employee benefits" on the appropriate business form or schedule.
The Tax Court clarified earlier this year in the Speltz decision that if you hire your spouse to qualify for a 105 plan, you can pay them in benefits only, rather than cash. This avoids payroll hassles. The key to making it work is to document your spouse's bona fide employment. Consider executing a written employment contract. And track their hours, weekly or monthly, to substantiate your deduction.
Here's the bottom line. The Section 105 plan lets you deduct 100% of your out-of-pocket costs, bypassing the usual 7.5% floor for itemized deductions. You'll also reduce any State income and self-employment taxes you would otherwise pay on amounts you deduct as plan benefits.
If you have any questions or would like our assistance in setting up a Section 105 plan, please contact me.