Medical Expense Reimbursement Accounts

Rising gas prices may capture headlines, but today’s soaring health care costs are an even more consistent financial threat. The National Coalition on Health Care reports that in 2006, the average family health insurance premium topped $1,200 per month. That’s more than the average family’s mortgage—and health care costs are rising faster than interest rates!

Raising your health insurance deductible just a few thousand dollars can cut your premium by up to half. But that leaves you responsible for out-of-pocket costs. And even if you itemize, those are deductible only to the extent they exceed 7.5% of your adjusted gross income. Is there a way to capture premium savings from high-deductible insurance and tax savings for out-of-pocket expenses? Fortunately, there are two. This post will discuss the first option, and we’ll post the next one in coming days.

If you have self-employment income, even from a startup or sideline business, you can take advantage of a little-known tax break to save a bundle on your family’s health care costs. Medical expense reimbursement plans (“MERPs”) let you reimburse your employees, their spouses, and their dependents for uninsured medical costs. Plan benefits are deductible by the business, and nontaxable to the employee. Here’s how they work:

· You have to establish the plan for employees. If you operate as a proprietorship, partnership, LLC, or “S” corporation, you’re considered “self-employed,” and not eligible. If you’re single, you can establish a C corporation and pay benefits to yourself as an employee. If you’re married, you can hire your spouse and pay benefits to them. (If you operate as an S corporation, you and your spouse are both considered self-employed. In that case, segregate part of your income through a proprietorship or C corporation and pay benefits through that entity.)

· You have to offer benefits to all employees. However, you can exclude those under age 25; those who regularly work less than 35 hours per week; those who work less than nine months out of the year; and those who have worked for you for less than three years.

· You’ll need a written plan document. No special IRS filings are required for plans with less than 100 employees. You’ll deduct benefits as “employee benefits” on your business return, which may also lower self-employment tax bill.

Example: You’re self-employed as a real estate agent. You hire your spouse to provide marketing support, and establish a MERP for his or her benefit. The plan covers your employee, their spouse (meaning you!) and your dependents.

Once you’ve established the plan, you can still deduct 100% of your health insurance costs. This includes major medical and supplemental coverage, Medicare Parts A and B coverage, qualified long-term care, and “Medigap” coverage. You can even reimburse your spouse for any after-tax premiums they pay through their employer.

You can also write off 100% of your out-of-pocket costs and bypass the 7.5% floor for itemized deductions. This includes routine expenses such as co-pays, deductibles, and prescriptions; occasional expenses such as eyeglasses, teeth cleaning, and chiropractic care; and big-ticket items like orthodontics, fertility treatments, and schools for learning-disabled children. It also includes nonprescription medicines and health-care supplies. You can reimburse your employee, or you can use business dollars to pay health-care providers directly