Consultant’s Corner: Can a 1099 Business Set Up an HRA Plan?

Q. I recently learned about Health Reimbursement Arrangement insurance plans. Are these applicable to someone running a 1099 business with no employees? If so, how could I take advantage of an HRA?

Sole proprietors cannot establish a Section 105 HRA, or medical reimbursement plan, solely for themselves and have the business reimburse them for out-of-pocket medical expenses on a tax-free basis; however, as we discuss in greater detail below, sole proprietors can establish a Section 105 medical reimbursement plan for a business if they can legitimately employ their spouse as a W-2 employee of the business. You should consult your accountant or CPA for a professional opinion on the tax savings that may result if you were to adopt a Section 105 HRA for your business.

While the business structure can affect the tax treatment of fringe benefit plans and the IRS has various rules with respect to accident and health plans in particular, the Section 105 HRA, or medical reimbursement plan, is popular with self-employed business owners. A Section 105 medical reimbursement plan is any plan or arrangement established in accordance with Internal Revenue Code Section 105 under which an employer reimburses an employee for uninsured health or accident expenses incurred by the employee or their dependents. Section 105 allows a 100% deduction for health insurance premiums and even allows companies to write off other non-insured medical, dental and vision expenses as well. Employees, including owner-employees, must draw a regular W-2 salary or wages from the business in order to qualify as employees under the IRS rules, but in most situations employers and employees can save Federal, State and Local income taxes, FICA (Social Security and Medicare) taxes, workers’ compensation, unemployment taxes, and state disability insurance (where applicable) payroll taxes with a Section 105 plan.

Due to the IRS limitations on health insurance and other medical expense deductions for the self-employed, a self-employed business owner who can legitimately employ his or her spouse as a W-2 employee and provide him or her with health insurance coverage through the business, which includes dependent coverage for the owner and other family members, will find a Section 105 plan particularly appealing. However, it is important to note that more than 2% of S corp owner-employees generally cannot participate in a Section 105 plan, and if they do, any benefits provided under the plan to the owner-employee and his or her spouse and dependents must be included in the owner-employee’s W-2 compensation as taxable wages.

It is important to note that the Affordable Care Act (a.k.a. Obamacare) has effectively eliminated the use of standalone Section 105 plans in all but very limited circumstances (one-employee plans). Assuming you can legitimately employee your spouse as a W-2 employee of your business, then your business may still be able to adopt a standalone Section 105 plan to reimburse your spouse’s and your (as her dependent) out-of-pocket medical expenses on a tax deductible basis.

For further reading:

http://www.claconnect.com/Employee-Benefit-Plans/New-Restrictions-Employer-Provided-Medical-Expense-Reimbursement-Plans.aspx#.VOPrNilUyu4

Even if a Section 105 plan is not an option, provided all of the IRS qualifications for claiming the self-employed health insurance deduction are met, self-employed business owners (i.e. sole proprietors, partners, shareholder-employees of S corps, and LLC members) can generally deduct 100% of the cost of their medical insurance premiums, including coverage for their spouse and dependents, as an adjustment to gross income on their personal tax return, Form 1040. However, under IRS rules, calculating the self-employed health insurance deduction any premium tax credits the taxpayer claims must also be taken into consideration. This is to prevent self-employed taxpayers from claimed a double tax benefit for the cost of their health insurance coverage. You can review IRS and related information on the Self-Employed Health Insurance Deduction at:

https://www.irs.gov/publications/p535/ch06.html#en_US_2014_publink1000208843

IRS guidance on the coordination of the Self-Employed Health Insurance Deduction with the Premium Tax Credit can be found in Rev. Proc. 2014-41:

http://www.irs.gov/pub/irs-drop/rp-14-41.pdf