MoneyWise can full administer these plans as well.
Benefits of the Plan
A Section 105 Plan allows a qualified business owner to deduct:
- Health insurance and dental insurance premiums for eligible employee(s) and family. This also includes qualified long-term care insurance.
- Out-of-pocket medical, dental, and vision care expenses for eligible employee(s) and family.
- Life, disability income, contact lens, hearing aid, Medicare Part A, Medicare Supplemental, optical/vision, and cancer insurance premiums for eligible employee(s).
Section 105 works well for sole proprietors who are able to legitimately employ a spouse who is active in the business. An employed spouse will be treated as any other employee, with the business owner offering medical benefits as part of the employee's compensation package.
A partner in a partnership will operate similarly to a sole proprietorship. The spouse of the partner must be a bona fide employee, thus receiving the benefits of the plan. However, a partnership between a husband and a wife will not qualify for the plan.
Unlike the sole proprietorship or partnership, it is not necessary for spousal employment to occur within the corporation. The corporate entity may provide and deduct benefits for the owner-employee director. Although sometimes misunderstood, even if a business is incorporated, all the proper components must be in place in order for a Section 105 medical reimbursement plan to be in compliance with Internal Revenue Code, DOL, and ERISA.
S-Corporations can qualify for the Plan without spousal employment; the owners/shareholders are considered employeees if they are active in the business. Restrictions apply to any shareholder owning more than two percent: they will be unable to receive medical benefits on a completely tax-free basis. These benefits are subject to state and federal income tax, but are not subject to FICA taxes. Family members (ncluding children and spouses) who do not have ownership are treated as if they did. Thus, they are not able to receive the benefits on a completely tax-free basis either.
Limited Liability Company
Treatment of a Limited Liability Company (LLC) with respect to a Section 105 medical reimbursement plan depends upon how the entity files for purposes of its federal tax return. They may file as a partnership, a corporation, or a sole proprietorship. Once the filing status is determined, the appropriate rules for each filing status apply.
Plan YearSection 105 Plans generally run on a calendar (tax) year, January-December. Tax deductions are then taken during tax filing the following year.
Carry OverRevenue Ruling 2002-41 includes an option for a Section 105 Plan to manage and capitalize on future deductibility of unused portions of a medical expense account. If an employee does not use their maximum, they can carry it over to future years, insuring future deductions for "shock" years of healthcare expenses.
The Carry Over applies to all employees on the plan. The maximum amount available under this benefit will accumulate over plan years and will be managed on an employee-by-employee basis. The business owner may choose to set a maximum Carry Over amount. Meanwhile, employees who utilize the Carry Over will have the amount available to them until the business ceases to exist, the plan terminates, there are zero Carry Over dollars remaining, or the employee becomes ineligible.
Employee Compensation Under a Section 105 PlanThe Internal Revenue Code allows self-employed business owners to compensate employees for services rendered in various forms. The most common form of course is cash wages, subject to the appropriate withholding taxes. In addition to wages, the IRS Code clearly explains that an employer may compensate employees in the form of medical benefits for services rendered. Pursuant to the Code, eligible and qualifying paid-for benefits are tax-free to the employee.
When the business owner compensates employees in the form of cash wages and medical benefits, they must ensure that the combination of the two equal the employee's total compensation package. When establishing benefit maximums, it is vital that the business owner understands that the benefits and the cash combined may not exceed what would normally be considered reasonable compensation for the job the employed-spouse is doing. The following example illustrates how a typical compensation package is determined...
...Jim owns his own business. Jim's wife, Mary, provides a valuable service to the farm by helping out in the field, running errands, and keeping the books. Jim decides to formally employ Mary and take advantage of a Section 105 medical plan (Health Reimbursement Arrangement). When establishing a compensation package for Mary, Jim evaluates her experience and the vital role she plays in the business. Jim compensates Mary $19,668 total per year in the following way...
1. Reimbursement for family health premiums:$9,859
2. Reimbursements for uninsured medical expenses:$5,809
3. W-2 Cash Wages:$4,000
TOTAL$19,668By allowing for a federal, state, and FICA tax deduction of the $15,340 of reimbursed expenses, Jim would receive $5,484 in actual tax dollar savings by taking advantage the Section 105 Plan.
NOTE: If Jim's farm files its taxes as a corporation, he would be the employee and a similar tax savings plan could be established without hiring Mary.
Qualified Medical ExpensesMedical expenses included under this type of plan are those defined in Section 213 of the Internal Revenue Code. As a general rule, medical care includes amounts paid for diagnosis, cure, mitigation, treatment, or prevention of a disease. Appropriate expenses include, but are not limited to...
- Health Insurance Premiums
- Dental Care Fees
- Hospital Bills
- Vision Care Fees
- Laboratory Fees
- Physician Fees
- Chiropractor Care Fees
- Orthodontia Costs
- Prescription Costs
- Psychiatric Care Fees
- Medical Supplies Costs
- A written employment agreement
- A log of hours worked by the employee
- An established cash (salary) compensation payment amount and schedule
- Name the insured (it is preferred that the insurance policy be in the employee's name).
- Maintain separate checking accounts (one for business use and the second for personal use).
- Pay for medical expenses (all medical expenses for the family should be paid by the employee from her/her personal account), and document all payments.