You’ve probably been asked by your clients before: “Can I deduct my health insurance?” or, “How can I reimburse my employees for health insurance premiums without triggering tax consequences?”
For small-business owners and sole proprietors, the most powerful and relevant options are Health Reimbursement Arrangements. There are two HRAs in particular that will be of most interest to your clients.
The One-Person Sec. 105 HRA is a traditional HRA integrated with a group health plan. It must be offered fairly to all employees. If the business only has one employee (the employee in most cases will be the owner), they can purchase individual insurance and integrate it with the HRA. However, if the employer were to hire another employee down the road, this HRA would have to be terminated since the employee would not have access to the same health insurance plan.
Here are the benefits of a One-Person Sec. 105 HRA:
- It turns a tax deduction on personal taxes (Form 1040) into a business deduction (Schedule C), reducing business and self-employment taxes.
- Health insurance premiums and medical expenses become a business expense, as opposed to the self-employed deduction, which only allows you to deduct premiums.
- It has the ability to create a net operating loss deduction (for future years), which is not possible with the self-employed deduction.
- It creates a full deduction for long-term-care insurance and prescribed over-the-counter drugs.
- It is not subject to the annual reimbursement limits of the QSEHRA (see below).
The Qualified Small Employer Health Reimbursement Arrangement, or QSEHRA, is the new stand-alone HRA that allows employers with fewer than 50 full-time employees to reimburse employees tax-free for individual insurance premiums and medical expenses. This allows every dollar being spent on employees for health insurance and medical expenses to be categorized as a business expense, avoiding payroll tax in the process.
The benefits of QSEHRAs include:
- They turn every dollar spent on employee health benefits into a business expense (Schedule C).
- They allow employers to control costs and set the maximum reimbursement limits allowable.
- They give employers a lot of flexibility to set reimbursement rates, choose eligibility, and select what they want to reimburse or not.
- They give employees ability to choose what they want as long as they meet the insurance requirements for
- “minimum essential coverage.”
- They provide an optimized approach to group benefits instead of a “one-size-fits-all” traditional group plan.
Determining the right strategy for your client
There are three things to consider when determining a tax strategy for your clients:
1. Business entity type;
2. Number of employees; and,
3. Who is to be reimbursed: the owner or the employee
The table below is a great tool to use to determine if the stand-alone 105 HRA, QSEHRA, a self-employed deduction, or a combination of strategies is best for your client to adopt.
SMALL BUSINESS HRA STRATEGIES
| Business structure | I work by myself (and have no plans to hire W-2 employees) | I have W-2 employees (or plan to hire soon) |
| Corporation (C corp; nonprofit; B corp; LLC taxed as a C corp) | QSEHRA or One-Person 105 HRA | QSEHRA for all |
| Proprietorship (sole proprietorship; single-member LLC) | If you're single: Self-employed deduction If you're married: Hire spouse and set up QSEHRA or One-Person 105 HRA | QSEHRA for W-2 employees, self-employed deduction for owners |
| Other Pass-Through Entity (S corp; partnership; LLC taxed as an S corp or partnership) | Self-employed deduction | QSEHRA for W-2 employees, self-employed deduction for owners |
The future of HRAs
We are expecting two new types of HRAs to be released in 2020, the “Excepted Benefit HRA” and the “Individual Integrated HRA.” These HRAs were proposed in October 2018 and are still being reviewed by the regulatory offices. Hopefully they will add more tax savings to small employers.
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