Is anybody still marketing Section 105 medical reimbursement plans to self-employed people? IRS made it a point to highlight the restrictions in recent years and it seems that most self-employed people and their advisers got the message. But today I received a call from a guy who says that some reputable firms including an ex-IRS lawyer are endorsing a health reimbursement arrangement where an unincorporated business owner pays the out-of-pocket health care expenses to his spouse/employee who is not a W-2 salaried employee. I just can’t imagine any reputable firm saying or doing that. I presume there must be something lost in translation.
I see three obstacles to a Section 105 plan for the spouse of a self-employed person:
The first obstacle is that IRS Publication 15 – the bible of small business employee benefits – makes it clear that in the category “One spouse employed by another” then “The wages for the services of an individual who works for his or her spouse in a trade or business are subject to income tax withholding and social security and Medicare taxes.” It seems unlikely that many self-employed people would wish to incur this burden simply for having the right to gain a tax advantage for health benefits. The high penalties for failures related to failure to file these taxes and corresponding paperwork should deter anyone from not filing for someone they identify as an employee. Either way, it is a difficult burden for an employer.
The basic issue in this first hurdle situation is that a spouse of the business owner is not an employee just because you say so or draft the business documents in that manner. There also needs to be a record of the employment taxes. This isn’t new and was not affected by the Affordable Care Act.
The second obstacle is that most states do not have an exemption from worker’s compensation insurance for a spouse who is a w-2 employee. In my state of Pennsylvania, for example, the exemptions would not normally work for a spouse employee. Other states may be different. A worker’s compensation for a single employee is expensive. In some cases it is even difficult to find for a self-employed person without a business owner’s insurance policy. Again, it seems unlikely that a person would voluntarily incur this expense simply to have an enhanced health benefit plan.
The third obstacle is that the Section 105 plan must be integrated with a group health insurance plan, thanks to the Affordable Care Act. The plan is not integrated simply because you have a document that says it is integrated. The benefits must be integrated in practice as well as in the plan design. The burden of claim integration is normally handled by a health insurance company. Some small businesses and self-employed choose to handle the claim administration themselves. As a practical matter, I can’t imagine a small business being able to satisfy a tax auditor’s curiosity about benefits integration if the Section 105 plan is administered separately from the insurance company.