Small businesses often use Section 105 Medical Reimbursement Plans as a solution for small business health insurance. Section 105 of the IRS code allows an employer to reimburse employees for their out-of-pocket medical costs and health insurance under an employer-sponsored health plan. These can be expenses incurred by the employee or his or her dependents, but they must be allowed under the plan document.
Quick Overview of Section 105 Plans
There are two common types of Section 105 Plans:
The first type is a Section 105 Plan used to self-fund (or self-insure) a health plan. In this case, the employer self-funds (or self-insures) health benefits rather than pay premiums to an insurance company.
The second type of Section 105 Plan is found in the form of medical reimbursement plans. There are various types of Section 105 Medical Reimbursement Plans including: Health Reimbursement Arrangements (HRAs), Medical Expense Reimbursement Plans (MERPs), Healthcare Reimbursement Plans (HRPs), Accident and Health Plans, and more.
Tip: In this article we are referring to a Section 105 Plan used as a stand-alone medical reimbursement plan (#2 above) -- where it is used to reimburse employees for individual health insurance premiums. This is often the basis of a Pure Defined Contribution Health Plan, and the type most commonly used by small businesses as a health insurance solution.
Can an Owner Participate in a Section 105 Medical Reimbursement Plan?
For small businesses using a Section 105 Medical Reimbursement Plan to reimburse employees for individual health insurance premiums, a common question is "can an owner participate in the Section 105 Plan?"
The answer is: Yes. Owners can and should participate in the company's Section 105 Plan. However, whether or not owners are eligible to receive reimbursements 100% tax free depends on how the company files taxes, and the owner's status.
C-Corporation Owners can fully participate in Section 105 Plans
C-Corporation ("C-Corp") owners can participate fully in Section 105 Plans. Just like non-owner employees, C-Corp owners may participate in a Section 105 Plan and receive all reimbursements 100% tax-free. C-Corp owners may use the Section 105 Plan to reimburse his or her qualified health insurance expenses, as well as family member's expenses. To summarize:
- C-Corp owners have full use of the solution, and receives reimbursements 100% tax free with no restrictions.
- The solution is an excellent option for tax-free business-owner health insurance.
Sole Proprietors, Partners, or S-Corp shareholders that own >2% of the company's shares can use the platform to reimburse health insurance expenses
The non-C-Corp owners specified above may receive reimbursement from their company for qualified health insurance premium expenses, and they may use the Section 105 platform to receive and track these reimbursements.
However, reimbursements made to these types of owners must be reported on the owner's/partner's wages (on their W-2 and 1040 forms) subject to federal income tax withholding. These reimbursements are exempt from Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) taxes, similar to profits passed through to the owner.
Further, the cost of the reimbursements is a deductible expense to the business, reducing the taxable income of the business and, thus, reducing the taxable income of the owners/partners (because these are flow-through tax entities).
IRS rules limit the deductibility of medical expenses for certain business owners. Using an online Section 105 software platform enables business owners to secure all income and payroll tax deductions to which they are legally entitled. Additionally, the online platform can track expenses to provide information needed for federal and state income and payroll tax filings.
Note that sole proprietors and other self-employed individuals receive an above-the-line tax deduction for personal health insurance premiums. IRS Notice 2008-1 (see http://www.irs.gov/pub/irs-drop/n-08-01.pdf) clarified that S-Corp owners may only take the self-employed health insurance premium tax deduction (on Form 1040) if the S-Corp pays for or reimburses the owner for the premiums.
For more information on Section 105 Medical Reimbursement Plans, see this Section 105 Plan FAQ.