What is a Section 105 HRA for the Self-Employed?
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.
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 approximately $2,500 per year. Savings may be more or less depending on the amount of deductions.
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.
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 7.5% of Adjusted Gross Income (AGI). Example: If AGI is $50,000 and you have $5,000 in out-of-pocket medical expenses, you can only deduct $1,250 ($50,000 X .075 = $3,750, and $5,000 - $3,750 = $1,250). With a spouse/employee Section 105 HRA, the employer can deduct the entire $5,000 as a business expense.
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