Section 105 Plan
How can you “hire” a spouse in a sole proprietorship without having to pay a wage, and where do you report it?
A Section 105 plan allows the employee-spouse to be given tax-free reimbursement checks to pay for substantiated heal costs incurred for the employee-spouse, their spouse, who just happens to be the business owner who is your client, and their dependent children. In other words, the client’s whole family is covered!
KEY POINT: The IRS admits this strategy works. For proof , see Rev. Rul. 71-588, TAM 9409006, and IRS Industry Specialized Program Settlement Guideline for Health Insurance Deductibility for Self-Employed Individuals (UIL No. 162.35-02, dated January 25, 2001). The Tax Court also agrees it works even when all of the employee-spouse’s compensation is in the form of Section 105 plan reimbursements. [See Speltz, Peter F. and Maureen, TC Summary Opinion 2006-25 (2006).]
A written Section 105 plan document is required. In order for Section 105 plan reimbursements paid to the employee-spouse to be a deductible compensation expense for the client’s business, the reimbursements, when combined with any other salary or benefits paid to the employee-spouse, must be reasonable in relation to the work actually performed by the employee-spouse [IRS Sec. 162(a)(1)]. Amounts reimbursed under the plan are simply reported as “employee benefits” on the tax return.
WARNING: If the client’s business has other employees, the Section 105 plan must be offered on a nondiscriminatory basis to them as well. Read the captioned information carefully before recommending this option to your clients.
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