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Small Business Employee Benefits and HR Blog

Section 105 Plan Eligibility - By Owner Status

Pure defined contribution health benefits are growing in popularity. They are a new way to offer health benefits without the cost or complication of group health insurance. The simplest way to think about pure defined contribution is that it's an allowance employees can use on health insurance -- just like a business expense account.

section 105 eligibility by owner

To set up the healthcare allowance, most businesses use a Section 105 medical reimbursement plan. Section 105 of the IRS code allows an employer to reimburse employees, and their dependents, for out-of-pocket health insurance costs.

Likewise, many business owners use a Section 105 medical reimbursement plan to increase their personal and business tax savings.

A common question from business owners and one-person nonprofits is "am I eligible to participate in the Section 105 plan?" This article reviews Section 105 owner participation for the following owner types and entities:

  • C-Corporation Owners
  • Sole Proprietors
  • S-Corporation Owners
  • Partners
  • LLC's
  • One-Person Nonprofits

Note: In this article we are referring to 'Section 105' as a limited-purpose Section 105 medical reimbursement plan, used as the foundation of a pure defined contribution health plan.

Section 105 Eligibility: C-Corporation Owners

C-Corporation ("C-Corp") owners may participate in the plan, and receive reimbursements 100% tax free. C-Corp owners may use the plan to reimburse his or her insurance expenses, as well as family members. To summarize:

  • Full use of Section 105 plan; receive reimbursements 100% tax free with no restrictions.

  • An excellent option for tax-free business-owner health insurance.

Section 105 Eligibility: Sole Proprietors

Sole proprietors may participate in a Section 105 plan platform (i.e. defined contribution software) for tracking purposes, but will not receive reimbursements tax-free. However, if the sole proprietor is married, and the sole proprietor's spouse is a W-2 employee, then the sole proprietor can receive the benefit tax-free. In this case, the plan is set up in the spouse's name and the sole-proprietor is listed as a dependent. To summarize:

  • Full use of the plan only if spouse is a W-2 employee.

  • Otherwise, the sole proprietor may use the platform to track medical expenses but reimbursements are not tax-free to the sole proprietor (reimbursements are subject to federal income tax withholding).

Section 105 Eligibility: Partners

Similar to sole proprietors, partners may participate in the Section 105 plan platform for tracking purposes, but will not receive reimbursements tax-free. However, if the partner is married, and the partner's spouse is a W-2 employee (but not a partner), then the partner can receive the benefit tax-free. In this case, the plan is set up in the spouse's name and the partner is listed as a dependent. To summarize:

  • Full use of the plan only if spouse is a W-2 employee, and spouse is not a business partner.

  • Otherwise, the partner may use the platform to track medical expenses but reimbursements are not tax-free to the partner (reimbursements are subject to federal income tax withholding).

Section 105 Eligibility: S-Corporation Owners

S-Corporation ("S-Corp") owners that own >2% of the company's shares and their spouse, parents, children, and grandchildren, may use the Section 105 plan platform to track medical expenses, but will not receive reimbursements tax-free. To summarize:

  • S-Corp owners may use the platform to track medical expenses but reimbursements are not tax-free to the S-Corp owner (reimbursements are subject to federal income tax withholding).

Section 105 Eligibility: LLC's

If the company is an LLC, owner participation varies based on the way the LLC files taxes (as a partnership, S-Corp, or C-Corp).

Section 105 Eligibility: One-Person Nonprofits and Churches

One-person nonprofits and churches (such as an Executive Director or a Pastor) may participate in an Section 105 plan and receive reimbursements 100% tax free. The plan may be used to reimburse his or her health insurance expenses, as well as family members. To summarize:

  • Full use of the plan; receive reimbursements 100% tax free with no restrictions.

  • An excellent option for nonprofit tax-free health insurance.

"Non-Eligible" Owners Should Still Enroll in the Section 105 Plan

As detailed above, whether or not owners are eligible to receive the full tax benefits of the plan depends on their tax filing status. If you are one of the owner types that must report reimbursements as taxable income, there still may be a reason to enroll yourself in the plan... business savings on FICA/FUTA.

Section 105 reimbursements are exempt from FICA/FUTA payroll taxes (7.65%), 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 therefore reducing the taxable income of the owners/partners (because these are flow-through tax entities). 

For more information on Section 105 Medical Reimbursement Plans, see this Section 105 Plan FAQ.

See this article for more information on defined contribution health care for small businesses.

What questions do you have about owner eligibility in a Section 105 defined contribution health plan? Leave a comment below.

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