The case of Speltz v. Commissioner (T.C. Summary Opinion 2006‑25) is a warning to small business owners using Section 105 plans. It illustrates how improper setup and poor documentation can lead to denied deductions and IRS penalties. In this case, a sole proprietor attempted to deduct medical expenses through a spousal employee Section 105 plan. Unfortunately, the court ruled against him due to several key compliance failures.
This article breaks down the details of the case and outlines practical lessons for business owners. If you want to use a Section 105 plan correctly, it’s critical to understand what went wrong in Speltz. Avoiding these mistakes can help you save thousands—and stay in good standing with the IRS.
What Happened in Speltz v. Commissioner?
Mr. Speltz operated a sole proprietorship and attempted to deduct medical expenses through a Section 105 plan. He claimed to have hired his wife as an employee and reimbursed her for the family’s healthcare costs. These included premiums, dental work, and other out-of-pocket expenses. He deducted these expenses on his Schedule C.
The IRS disallowed the deductions, arguing that no valid employment relationship existed. They claimed the plan was not formalized, and payments lacked proper documentation. The Tax Court agreed with the IRS. As a result, Mr. Speltz owed back taxes and penalties.
This case shows how good intentions can fail without proper setup. A Section 105 plan must be carefully structured and well-documented to qualify for tax benefits. Simply calling someone an employee is not enough.
No Written Plan Document
One major issue in Speltz was the absence of a formal written Section 105 plan. IRS rules require a written plan document that outlines key elements. This includes employee eligibility, covered expenses, and reimbursement procedures. Without it, the plan is considered noncompliant.
Mr. Speltz did not present a written plan during the audit or court case. This omission was a major reason the IRS denied his deductions. The court emphasized that plan documentation is essential for Section 105 benefits. Verbal agreements or informal arrangements are not sufficient.
To avoid this issue, every business using a Section 105 plan should draft a compliant plan document. The document must be in place before any reimbursements occur. It should be updated annually and retained in business records.
No Evidence of Bona Fide Employment
The second major issue was the lack of a real employer-employee relationship between Mr. Speltz and his wife. While he claimed his wife worked in the business, there were no time logs, job descriptions, or payroll records. The court found no credible evidence that she was a bona fide employee.
For a spousal employee arrangement to be valid, the spouse must perform real work. Tasks should be clearly defined and performed regularly. Wages must be reasonable and actually paid. Ideally, payments should go through payroll and be reported on a W-2.
Mr. Speltz could not show that any of this occurred. His wife was not paid a wage and did not receive a W-2. This undermined the legitimacy of the employment relationship. As a result, the IRS treated the reimbursements as nondeductible personal expenses.
Inadequate Documentation and Reimbursement Process
The third issue in the case was the lack of proper reimbursement procedures. Mr. Speltz reimbursed expenses but failed to document them thoroughly. He could not produce receipts or statements verifying the expenses. He also did not show that reimbursements were made from a business account.
Section 105 plans require substantiation for every expense. Employees must submit receipts, insurance statements, or other supporting documents. Employers must keep copies and pay reimbursements directly from business funds. Casual or undocumented payments are not allowed.
Because Mr. Speltz lacked receipts and records, the IRS assumed the plan was not legitimate. The Tax Court supported that decision. Poor documentation is one of the easiest ways to lose deductions in an audit.
Lessons for Business Owners
The Speltz case offers clear lessons for anyone considering a Section 105 plan. First, you must use a formal written plan document. Second, you need a real employee relationship—especially if your spouse is the employee. Third, you must document every expense and reimbursement carefully.
If you’re a sole proprietor using a spousal employee strategy, follow the rules strictly. Pay your spouse a fair wage and issue a W-2. Maintain time logs, job descriptions, and personnel records. Set up a clear reimbursement process with proper tracking and receipts.
These steps are not just technicalities—they are the foundation of a compliant Section 105 plan. When done correctly, this strategy offers powerful tax benefits. But when done poorly, it invites IRS scrutiny and costly consequences.
Conclusion
Speltz v. Commissioner is a textbook example of what not to do when setting up a Section 105 plan. The court ruled against the taxpayer because of missing documents, poor payroll practices, and unverified reimbursements. If you want to use a Section 105 plan to deduct family medical expenses, do it the right way. Create a written plan, pay your employee spouse properly, and document everything. These extra steps could save you thousands—and help you avoid serious IRS trouble.
