I thought a self-employed person could not participate in an HRA or medical reimbursement plan?
A self-employed person may hire his/her spouse and establish a fringe benefit plan for him/her to reimburse medical expenses of the employee, his/her spouse and dependents.
Rev-ruling 71-588
ISSUES:
(1) Whether A, a sole proprietor, is entitled to deduct under section 162(a) of the Internal Revenue Code amounts paid to B, A's spouse and employee, as reimbursement of medical expenses under an employer-provided accident or health plan.
(2) Whether amounts B receives as reimbursement of expenses that B incurs on behalf of B, A, and their dependents are excluded from B's gross income under section 105(b).
FACTS:
A operates a consulting business as a sole proprietor and employs B, A's spouse, to perform certain services in connection with the business. B receives compensation for the services B performs and includes the compensation in gross income on the couple's jointly-filed federal income tax return. A adopted a written employer-provided accident and health plan that, by its terms, covers all employees of A's business. During the year in question, A reimbursed B, pursuant to the plan, for the expenses of medical care that B incurred on behalf of B, A, and their dependents. You agreed that there is a bona fide employer-employee relationship between A and B.
LAW:
Section 162(a) of the Code allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business, including reasonable salaries and other compensation for services rendered.
Section 213(a) of the Code allows a deduction for the expenses paid during the taxable year, not compensated by insurance or otherwise, for medical care of the taxpayer, the taxpayer's spouse, or a dependent, to the extent that such expenses exceed 7.5 percent of the taxpayer's adjusted gross income. The term "medical care" is defined in section 213(d).
Section 105(b) of the Code generally allows an employee to exclude from gross income employer-paid reimbursements for the expenses of medical care (as defined in section 213(d)) of the employee and the employee's spouse and dependents.
Rev. Rul. 71-588, 1971-2 C.B. 91, holds that amounts paid by a sole proprietor to his spouse, a bona fide employee of the business, under an accident and health plan covering all employees are (1) excludable from the employee-spouse's gross income under section 105(b) of the Code and (2) deductible by the employer-spouse as a business expense under section 162(a).
CONCLUSION:
Applying the law to the facts of the present case, the amounts paid to B under the plan as reimbursement for medical expenses are deductible by A as a business expense under section 162(a) of the Code. Further, B may exclude these amounts from gross income under section 105(b).
A copy of this technical advice memorandum is to be given to the taxpayer. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.
How many hours does a spouse have to work in the business for the HRA to be effective?
There really is not a definitive number of hours worked in order for the plan to be reasonable. One must evaluate the whole compensation package provided to the employee (pay plus fringe benefits) to determine whether it is reasonable compensation for the work performed.
What kind of record keeping is involved for a business owner?
Record keeping requirements are the same as for payroll purposes - all payroll tax filings (W2's, 941's etc.), and their backup detail. In addition, you will want to keep copies of the plan documents and the receipts for all medical expenses that are reimbursed. These records should be kept for a minimum of three years and some records such as the plan doc and the payroll tax filings should be kept indefinitely.
Are there limits to the amount of expenses that can be reimbursed?
To reimburse out-of-pocket medical expenses, an upper limit must be established and this is determined when the plan is set up. The total of all medical expenses reimbursed must be part of a reasonable compensation package, thus the amount is directly related to hours and work performed by the employee.
Will this work if the sole-proprietor is not married?
A sole-proprietor can set up an HRA to provide benefits for his other employees but will not realize any benefits for himself unless it is through spousal employment.
How often do the documents need to be updated?
The plan should be reviewed annually to ensure it is meeting the needs of the participants. Amendments can then be made for the next plan year. As these plans are rolled forward from one year to the next, they will automatically be updated by any changes made through our programming for legal and legislative changes that have occurred throughout the year. |
