In today's times, it is very hard for small business owner's to compete with big business when it comes to recruiting high value employees. While we will probably never be able to compete when it comes to big benefit packages, we still have a few tax "tricks" up our sleeve - one is in the form of a tax-saving Section 105 Medical Reimbursement Plan.
What is a Section 105 Plan?
A Section 105 plan allows businesses to reimburse employees for medical costs that are not covered by their health insurance. These are commonly called an HRA (Health Reimbursement Arrangements) or HRP (Healthcare Reimbursement Plan). All reimbursements are 100% tax deductible by your business and also your employees.
How does it work?
Section 105 plans are similar to Section 125 plans in that you must have a written plan. In this written plan you must set the requirements for eligibility how much you will contribute for each employee per month/year. You are allowed to exclude certain employees from eligibility, but only those the ACA law has allowed:
- Employees who have not completed 3 years of service;
- Employees younger than 25;
- Part-time or seasonal workers; &
- Union workers covered by collective bargaining agreement.
You can set different amounts for different classes of employees - for example, you can reimburse $300 each month to managers and $200 each month to entry-level employees. That being said, you cannot discriminate in favor of highly-compensated employees when it comes to who can participate.
What benefits can a Section 105 plan include?
Pre-2014, you could reimburse employees with pre-tax dollars for health insurance premiums for policies employees purchased on their own. Now with the implementation of the Affordable Car Act, you must also offer to pay for at least part of a group health insurance plan. If your employee is covered under their spouses plan, then your 105 plan may reimburse the employee for the portion of the group health insurance premiums they had to pay plus medical expenses that the insurance did not cover - deductibles, copays, prescriptions.
However, there are some "excepted benefits" that are allowed in a Section 105 plan that will not require you to buy any group health insurance:
- Accident and disability insurance;
- Supplemental liability insurance;
- Worker's compensation;
- Dental and vision benefits;
- Medicare supplemental insurance;
- TRICARE supplemental insurance.
As the business owner - Can I participate?
Yes and no - the answer depends on how you file taxes. A C-Corp owner may participate and receive all reimbursements 100% tax free. Sole Proprietors, Partnerships, or S-Corp shareholders that own more than 2% of the company's shares will still be able to receive medical reimbursements but they must be reported on the owner/partner's W-2 and would be subject to federal taxes. However, if your spouse is an employee of the business you can receive tax-free reimbursements - this is whole other tax strategy!
What are the benefits to me - the small business owner?
You are able to deduct 100% of the costs associated with the Section 105 plan as a business expense. All costs are predictable because you have decided and documented the amounts you are willing to contribute to each employee. Also, there are no actual costs incurred until the employee requests and receives reimbursement.
How are Section 105 plans administered?
Administration is easy once you have the written plan in place. You will also need to stay compliant with several laws - ERISA, HIPPA, COBRA, and ACA. You can stay in compliance by hiring a third party to manage the plan or use a software provider. Once setup, Section 105 plan administration becomes a payroll function - reimbursements are simply added to employees paychecks.