Lets face it, sometimes life hits you and medical costs rise higher than you would ever hope for. Fortunately for those business owners there may be some options available to get a tax savings from it.

Now, before we go any further, I want to be clear. What we are discussing here is medical costs over above health insurance. If you have not checked out our first two posts, do so now:

How Does the Deduction For Self-Employed Health Insurance Work?

What Is An HSA and How Do They Work?

You should already automatically be taking care of those two items first. Now, if after that you still have high medical costs that is what we are going to be talking about today. 

One final key note is that this specific post is related to those small business owners that do not have other employees, this would be for solo business owners with just themselves or a spouse as an employee.

We are going to be talking about a Section 105 medical reimbursement plan or health reimbursement arrangement.

What Is a Section 105 Plan?

If you qualify a Section 105 plan turns personal medical expenses into a business deduction.

How Do I Qualify for a Section 105 Plan?

1. Have 1 (one) employee only
2. Operate your business as one of the following:
   • Sole Proprietorship (Schedule C)
   • Partnership (Form 1065)
   • Rental Property (Schedule E)
   • C Corporation (Form 1120)

How Does a Section 105 Plan Work?

You would need to ensure you have the correct paperwork and plan designed (this is key) but then it would reimburse the employee for medical costs incurred.

The "employee" would either be you if you are single or your spouse. 

• Single
  • You'd have to be operating your business as a C Corporation and you would have the company provide Section 105 benefits to you as the employee.
• Married
  • Hire your spouse as the employee and have the plan reimburse them for medical expenses incurred. The reimbursement would include expenses for the following:
    • the employee (your spouse)
    • the employee's spouse (you)
    • the employee's dependents (your children)
    • any child of the employee under 27

Once you have it setup and the correct employee chosen you would reimburse them for medical expenses incurred, turning these into deductible business expenses which you would record as "employee welfare benefits". 

Can You Give An Example of a Section 105 Plan?

Of course! Lets say you are operating your business as a sole proprietor and you have high medical costs you would need to ensure you hired your spouse in the business and then develop a Section 105 plan to reimburse your employee (your spouse) and their family (you and your children).

Lets say you have $15,000 in medical expenses and were in the 24% tax bracket. By setting up a Section 105 plan you would be saving over $5,800 in taxes and that is before considering possible state taxes.

What Other Things Should I Consider Regarding a Section 105 Plan?

• You need to ensure this is setup correctly or the deduction could be deemed invalid.
• If you are operating as a sole proprietor the tax law does not consider you an employee of your business which is why hiring the spouse is required.
• If you hire your spouse they must actually be doing work in the business that would make sense for the pay they are receiving (medical reimbursements).
• If you have other employees in your business you would not want to do a Section 105 Plan and would instead look at other HRA options, which we will be discussing in our next post.
• If you have multiple businesses, you would need to consider the employees in all of you and your spouses's businesses. Ex: If you have one business with no employees but another business with 10 you would not qualify for the Section 105 as you would need to implement it in your business with employees as well.
• You may have noticed that we did not mention an S Corp as a qualifying business. If you operate as an S Corp you may need to consider a work around as you would not be able to do a Section 105 Plan within an S Corp.

As you can tell, this stuff can get fairly complicated especially considering the various documents you would need to get it setup or if you need to do some type of work around. 

Fortunately, we deep dive on this specific strategy in TaxElm. If you want more information on this or want plan documents, reimbursement request forms, time sheet examples, etc. consider joining TaxElm which will provide so many more benefits than just this one strategy.