Nations Business (Sept 1, 1994)

A Potential Break For Sole Proprietors

Because medical expenses are deductible only to the extent that they exceed 7.5 percent of adjusted gross income, most taxpayers don't qualify for this deduction.

But self-employed persons, sole proprietors, and partners got a special break from Congress in legislation passed in 1986 and were allowed to deduct up to 25 percent of medical and dental insurance premiums paid for coverage for themselves and their families; the deduction was not subject to the 7.5 percent floor.

This provision, which lawmakers have already extended retroactively once, has expired for the tax years beginning after 1993. Although there is a good chance that the tax break will renewed again, it is not certain.

Thus, self-employed individuals should be aware of some strategies for increasing their deductions for health-insurance premiums. For example, if a sole proprietor decides to incorporate, all of the medical-insurance premiums paid by the corporation would then be deductible by the corporation and not includable in the owner's income. This would amount to a 100 percent deduction for medical expenses. Of course, there are many other factors to consider before incorporating.

A recent IRS ruling may allow a similar break for sole proprietor and partners. In that ruling, a sole proprietor employed her husband to work in her business. The husband was compensated for the work he performed and was issued a W-2 form for the wages. The sole proprietor adopted a self-insured medical-reimbursement plan and reimbursed the husband's medical expenses, including the cost of health-insurance premiums paid by the husband on behalf of his family, which included his wife, the employer.

The IRS allowed the sole proprietor to deduct the cost of these reimbursements, and the husband was not required to include the reimbursement in income. In this way, they received a 100 percent deduction for medical expenses.

Keep in mind that the ruling is a private one and cannot be applied in all cases. Nevertheless, it showed how the IRS is thinking about this problem.

Note also that this was a self-insured plan that worked well in this situation. If there were more employees, however, the sole proprietor would have to offer the plan to them as well. As an alternative, the sole proprietor could adopt an insured plan that would allow her to cover only the husband. There is no nondiscrimination requirement for an insured plan. Compensation paid to the spouse is subject to additional payroll levies, including Social Security and Medicare taxes. But a spouse's wages are exempt from the federal unemployment tax and most states unemployment taxes.

In any event, the tax savings in obtaining the medical-expense deduction usually outweigh those additional costs. Check with your accountant to help make this determination.

Source:
Tax lawyer Albert B. Ellentuck is counsel to the Washington, D.C., law firm of King & Nordlinger.

Back

© 1996 - 2007 Flex Benefits & Administration
Email: kent@seedplan.com