If you are self-employed or a single-member limited liability company (LLC) taxed as a proprietorship and your spouse is your only eligible employee:

• Your business can reimburse your employee-spouse for the cost of health insurance, whether purchased through a public health insurance exchange or an insurance company.
• Your health insurance reimbursement to your employee-spouse works with a family coverage policy, meaning that you reimburse your spouse for coverage that includes you and your family’s dependents.
• Your business deducts the reimbursement to your spouse as a business expense. It’s an employee fringe benefit.
• Your spouse receives the benefit tax-free.
• Your reimbursement plan can include all medical expenses. You don’t have to limit it to health insurance.

Structuring the reimbursement correctly

• creates a business expense deduction,
• saves on employment and income taxes for the business owner and the employee-spouse,
• avoids the $100-a-day penalty for reimbursing individually purchased insurance, and
• avoids any state-imposed individual mandate penalty for not having health insurance. (The Tax Cuts and Jobs Act eliminated the federal mandate penalty, so no worries there.)

If the insurance is purchased through an exchange, individuals may receive premium tax credits—government subsidies to help pay the insurance premium cost. To receive subsidized coverage, an individual must have a low income (not more than 400 percent of the federal poverty level) and must not be eligible for an employer-sponsored group plan

Unlike most other citizens, proprietorships cash in on tax savings when utilizing this plan.

Big Picture

Healthcare reform has created significant obligations—and a ton of confusion—for everyone, including restrictions and requirements for insurers and employers that provide coverage.

For the self-employed and single-member LLCs taxed as proprietorships that have a spouse as their only eligible employee, the business reimbursement of the employee spouse’s health insurance coverage obtained on a public health insurance exchange means up to four tax benefits (three for sure).

 

1. The employee’s spouse does not recognize income on the employer-spouse’s reimbursement.
2. The owner avoids the super large ($100-a-day) penalty for reimbursing an employee for individually purchased health insurance.
3. The owner takes a tax-favored business deduction for the reimbursement payment.
4. The spouse might qualify for a premium tax credit and could purchase a subsidized exchange plan that covers the spouse and the owner (and other dependents), saving both the owner and the spouse money.

Beating the Obstacles

Before we discuss the tax advantages in detail, it’s important to understand some of the obstacles that the Schedule C business owner and spouse are up against.

Obstacle 1. Possible Health Insurance Mandate

Federal mandate: As of 2019, there is no federal income tax penalty for not having health insurance. The individual mandate penalty under the Affordable Care Act (ACA) was reduced to $0 by the Tax Cuts and Jobs Act starting in 2019.

State mandate: Some states (i.e., California, Massachusetts, New Jersey, Rhode Island, and the District of Columbia) have their own individual mandates and penalties for not having health insurance. Vermont has a mandate, but no monetary penalties. You may want to check your state’s requirements.

Obstacle 2. $100-a-Day Penalty

The second obstacle is health care reform’s general prohibition on employers paying for individual policies for their employees, which carries with it hefty penalties ($100 per day per individual).

Obstacle 3. The Plan

The third obstacle is the establishment of the reimbursement arrangement itself. Any arrangement that claims a tax advantage based on medical coverage is a “plan,” which means certain documentation and other requirements.

Key point. You are about to smile as you see how you can hurdle the obstacles with relative ease described below.

Advantage 1: Tax-Free to Employee-Spouse

The tax code allows employers to reimburse or otherwise pay medical-related expenses of an employee, the employee’s spouse, and the employee’s dependents without including those amounts in the employee’s gross income.

This is big. It’s a non-taxable fringe benefit. The family medical reimbursement is not W-2 income to the employee spouse. Accordingly, the employee-spouse does not pay any federal income or employment taxes on the reimbursement. And you, the employer, also do not pay any federal employment taxes (Social Security, Medicare, or federal unemployment).

Advantage 2: Escape the $100-a-Day Penalty

Healthcare reform generally prohibits the practice of reimbursing employees for individual policies. However, that prohibition does not apply to a plan that covers fewer than two eligible employees.

So, the proprietorship can reimburse the employee-spouse without including the reimbursement in the spouse’s gross income, while also saving on employment taxes and avoiding penalties that apply to businesses with two or more eligible employees.

Advantage 3: Business Deduction

In addition to the exclusion from federal payroll taxes, the owner takes a Schedule C business deduction for the medical reimbursement payment. The business deduction does two things:

1. It reduces the owner’s self-employment taxes.
2. It reduces the owner’s income taxes.

And remember, the spouse received the medical reimbursement as a tax-free fringe benefit. The bottom line is that the medical reimbursement is deductible by the proprietor and not taxable to the employee spouse.

Advantage 4: Government Subsidy

The fourth advantage relates to the spouse’s ability to still qualify for premium subsidies in the exchange. Generally speaking, if an individual is eligible for an employer-sponsored group health plan, the individual is not eligible for a premium tax credit.

In this instance, however, because the plan covers only one employee, the arrangement falls outside the definition of an employer-sponsored plan. Therefore, the reimbursement by itself does not cause the owner or spouse to lose eligibility for the premium tax credit.

If the spouse qualifies for the premium tax credit, you as a Schedule C business owner can reimburse the spouse for the net cost of the health insurance. In effect, this gives you and your spouse both tax-deductible reimbursement from the business and the subsidized premium tax credit from the federal government via the exchange.

Of course, you may well have income that exceeds 400 percent of the federal poverty line (the actual dollar amount depends on your location and your number of dependents). With income too high, there is no government subsidy, but tax-deductible business reimbursement remains.

Putting the Plan in Place

Your first step is to put your medical reimbursement plan in writing. You need to do this to comply with IRS Regulation Section 1.105-11(b), which defines a self-insured medical reimbursement plan as a separate written plan for the benefit of employees that provides for reimbursement of employee medical expenses referred to in IRC Section 105(b).

To help you put your plan in place, here’s a sample Section 105 medical reimbursement plan document. This document is for 2020 and later, and it works for 2025, as no new legislation has changed the rules.

Four things to keep in mind about the plan:

1. Make the plan cover the employee-spouse.
2. Make the plan a family plan.
3. Require the employee-spouse to submit medical expenses monthly.
4. Reimburse the employee-spouse for every medical expense monthly (doing it monthly makes the plan business-like).

Also, to help you get your arms around this great benefit, take a moment to read the Updated Blueprint for Employee-Spouse 105-HRA (Health Reimbursement Arrangement).

Takeaways

When you implement the employee-spouse health reimbursement strategy:

1. Your proprietorship deducts the reimbursement as a business expense. You save income and self-employment taxes.
2. Your employee spouse does not report the reimbursement as income.
3. Your business saves on employment taxes.
4. Your spouse saves on employment taxes.
5. You avoid the significant penalties that apply to reimbursing individually purchased health insurance.
6. You and your spouse may avoid state tax penalties under your state’s possible individual mandate.
7. You and your spouse potentially save money through premium tax credits in the exchange.

If you can employ your spouse in your Schedule C business and you have no other employees, you can start saving money now. Employ your spouse, get all the tax advantages, obtain the health insurance coverage you need, and avoid health care reform penalties.

At Provident CPAs, we specialize in helping clients adapt to changing economic conditions. Whether you’re a business owner or an individual looking to optimize your tax strategy, our team is here to guide you through the complexities of today’s tax landscape. Contact us today to learn more about how we can help you achieve financial independence, even in the face of economic uncertainty.

This post serves solely for informational purposes and should not be construed as legal, business, or tax advice. Individuals should seek guidance from their attorney, business advisor, or tax advisor regarding the matters discussed herein. Provident CPAs assumes no responsibility for actions taken based on the information provided in this post.