Section 105 HRA Plans Saving Thousands in Taxes for the Self-Employed
What is a Section 105 HRA
One way the self-employed can reduce the high cost of health insurance and out-of-pocket medical expenses is to establish a Section 105 HRA plan. Section 105 HRA plans are Medical Expense Reimbursement Plans that allow you to save substantial tax dollars on insurance premiums and out-of-pocket medical expenses not covered by insurance.
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. (Click the blue links to see Section 105 of the Code plus the Revenue and Letter Rulings that allow you to take advantage of this concept.)
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.
Section 105 of the Internal Revenue Code has been around since 1954. Soon thereafter Section 105 plans gained popularity in the agricultural industry as farmers utilized the plans to provide these tax deductions to their family members employed on the farm. Today Section 105 HRA plans are widely accepted with over 50,000 small business owners taking advantage of the tax deduction. Average tax savings are more than $2,500 per year. Savings may be more or less depending on the amount of deductions.
Because the Affordable Care Act (ACA) made the $2 million annual/lifetime benefit requirement for plans with 2 or more employees, all one person HRA plans survived this new ACA/ObamaCare regulation, and are still a viable benefit option. What does this mean for many intelligent, self-employed business owners, or potential new small business owners? Establish a Section 105 HRA through Core Documents and reimburse your insurance premium and out-of-pocket medical, dental, and vision expenses and save thousands of dollars you couldn’t deduct otherwise.
I can’t think of a better reason to start a small family business than to use those funds, tax-free to pay for the extremely high cost of healthcare in a post-ObamaCare world.
Who Can Participate
Section 105 HRA plans are best suited for employees of sole proprietors, corporations, limited liability companies, and partnerships. Business owners generally can’t participate in a Section 105 HRA plan. This is why the spouse/employee approach has become so popular. However, C corporation and S corporation owners can participate as long as they’re receving a regular paycheck as an employee.
Aren’t These Expenses Already Deductible by the Self-Employed
Good question. The answer is yes, however the deductions are limited as outlined below.
Self-Employed Health Insurance Deductions without a Section 105 HRA.
Effective in 2003 and thereafter 100% of health insurance premiums became tax deductible for the self-employed. The self-employed can take this deduction whether they itemize or not. However, most people are unaware that the 100% health insurance deduction only affects income tax and does not reduce income when calculating Social Security taxes (Self-Employment Tax). The 15.3% Self-Employment tax is still paid on insurance premiums. If an employer elects to establish a Section 105 HRA for a spouse/employee the Social Security taxes are eliminated for the employee as well as the employer. The Section 105 HRA allows employers to take this additional 15.3% deduction.
Self-Employed Medical Expense Deductions without a Section 105 HRA
Medical expenses are already tax deductible for the self-employed, aren’t they? Yes, they are, if they itemize deductions, however, they can only write-off medical expenses that are in excess of 10% of Adjusted Gross Income (AGI). Example: If AGI is $100,000 and you have $12,500 in out-of-pocket medical expenses, you can only deduct $2,500 ($100,000 X .10 = $10,000, so $12,50 in medical expenses – $10,000 = $2,500 in excess you can deduct). With a spouse/employee Section 105 HRA, the employer can deduct the entire $12,500 as a business expense.
How To Establish a $149 Section 105 HRA And Employ Your Spouse
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 offered a coordinated issue paper regarding Section 105 and the spouse/employee issue 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”.
The question is, does the spouse provide meaningful services to the company, and would the employer have to hire someone else to provide the same services if the spouse was not available for employment? If the answer is yes, then you qualify to establish a Section 105 HRA plan for your spouse.
How To Establish a Section 105 HRA and Employ Your Spouse
Order the Section 105 HRA complete kit which includes: Resolution, Plan Document, Summary Plan Description, Forms, and Administrative Sections from Core Documents by following the links in the blue sidebar on the right side of this page to either the “Online 105 Order Form” or the “Fax 105 Order Form”.
Apply for a Federal Employer Identification Number (FEIN). You can’t be an employer without a FEIN. You can apply for the FEIN using IRS SS-4 Form. There are hundreds of payroll services who will process your payroll, report, and deposit payroll taxes for a minimal cost.
When hiring your spouse you need a formal hiring process that should include the completion of a standard Employment Application, W-4 form, and an I-9 form. Core Documents will provide you with a work agreement that outlines the duties and responsibilities of the employee, plus the total compensation package.
Next, and very important, is developing a reasonable compensation for the services provided. Some factors to consider would be wages paid for similar services, experience, qualifications, complexity of the job, and responsibilities. Once you’ve established a reasonable wage, then determine which insurance and medical expenses that can be deducted. The difference is the reasonable salary that should be set up on a systematic payroll either bi-weekly, monthly or quarterly.
Notify your health insurance carrier that you will be changing the name of the primary policyholder to the spouse/employee.
Your spouse should set up a separate checking account to deposit earnings and medical expenses you’ve reimbursed. The paycheck and the medical expense reimbursements should be in the employee’s name and deposited into their individual or joint account. Don’t deposit payroll checks into the business account.
You should keep records of the hours worked and jobs performed for all employees.
Section 105 HRA Plan Document Package Includes:
Section 105 Plan Document – Section 105 Plan Documents are personally prepared for each client and should be accepted and signed by an Owner or Officer of the Company and kept on file for review by employees, accountants, IRS, etc.
Documents can be purchased in PDF format emailed to you ASAP for $149, or $199 in the deluxe printed version in a 3-ring binder via Priority Mail, AND in PDF version via email as soon as your document is completed.
Section 105 HRA Summary Plan Description (SPD) – Required for each employee. Explains the Section 105 Plan Purpose, Who is Eligible, How To Enroll, etc. in easy to read language. Also includes all information required by the Internal Revenue regarding the Section 105 Plan Year Start and End Dates, Agent for Legal Service, Fed. ID#, and information regarding COBRA, FMLA, and required DOL information.
Section 105 Election and Claim Form – Personalized for the Company it will include the Section 105 Election Agreement and Claim Form to submit bills for reimbursement by the Company.
Section 105 Administrative Handbook – Includes sections on: Section 105 Administration, Non-Discrimination Testing, and Reporting and Disclosure information. You will be provided with instructions regarding Section 105 Plan setup, maintenance procedures, etc.
Resolution to Adopt a Section 105 Plan– Includes minutes of the meeting to adopt the Section 105 Plan as an employee benefit.
Core Documents has been providing Section 105 HRA plans for small business owners since 1997. They would be happy to assist you in establishing your own small self-funded Section 105 HRA plan document and administrative kit for only $149. Call us today at 1-888-755-3373 and talk to a Plan Consultant about how we can assist you and reduce 2014 income tax liability.