Owners of a C-Corporation are in a great position to realize the tax-free benefits of a Section 105 plan. They may entirely deduct the cost of such a plan from the taxable income of the business. The benefit is included within the W-2 statements of their employees as non-taxable income.
Since C-Corporations are not pass-through entities, owners do not have to worry about an additional self-employment tax unless they receive self-employment income on a 1099-MISC form. However, since this is not tax-advantageous, most C-Corporation owners choose to receive their income through a W-2 or dividend distribution.
Since owners of C-Corporations are recognized as employees, there is no need to employee a family member (or anyone else) in order to qualify for a Section 105 plan and realize its benefits. There are also no limitations on contributions made to the plan if contributions follow the Section 105 plan documentation.
C-Corporations must ensure that they follow the IRS and Department of Labor rules when they create the Section 105 plan. In general, they must abide by the following:
- Create a written legal plan document that includes:
- Name of the plan administrator
- Description of plan benefits
- Standard of review for benefit decisions
- Eligibility criteria
- Amount the participant must pay towards coverage
- Plan sponsor amendment and termination procedures
- Any waiting period required before eligibility for the plan begins
- A statement of how the plan is funded
- Ensure that the plan complies with COBRA, HIPAA, ERISA and ACA requirements.
- COBRA – if the plan has more than twenty participants, it must offer continued medical benefits to terminated employees for a set period. The terminated employee must pay for their benefits with their own funds, but the employer cannot drop them from group coverage until the time limit is reach, or until the terminated employee becomes eligible for another medical insurance plan (whichever occurs first).
- HIPAA – HIPAA requirements require that protected health information should be given to the company processing reimbursement claims and should be held confidentially.
- ERISA – Under ERISA, Section 105 plans are included as employee welfare plans. Summary plan descriptions and information must be provided to each employee. Employers cannot endorse any specific health insurance plan and must not directly pay for a specific plan.
- ACA – The ACA requires that no annual or lifetime limits can be placed on essential health benefits. Employees also cannhttps://www.dol.gov/general/topic/health-plans/erisaot wait over 90 days for health care reimbursement, and plans must allow coverage for individuals up to age 26 under their parents’ plans.
C-Corporations may choose any type of Section 105 plan they like – a self-insured plan, group-integrated HRA plan, a Health Savings Account (HSA), or stand-alone one-person HRA. Expenses for the Section 105 plan are deducted on Form 1120 directly from taxable income. Premiums and reimbursement payments flow through to the owner’s and employee’s W-2 forms as fringe benefits and are not subject to further taxation.
Section 105 Plan Under a C-Corporation: An Example
C-Corporations are perhaps the best legal structure to enact a Section 105 benefit plan with. There are virtually no limits on the amount of contributions that can be made to an employee (if the same benefits are available to all employees of the same class), and they are fully tax-deductible to both the corporation and the business owner, even if the owner’s spouse does not work for the company.
Let’s look at ABC Corporation, whose sole shareholder, Alex, owns 100% of the company. ABC Corporation has no employees besides Alex, and he decides to enact a Section 105 plan for himself. He requires a lot of medical care throughout the year due to a chronic back problem he has had since he was a teenager. He also is diabetic and requires expensive medication to maintain his health. He is married and has three children, one of whom is a newborn. He estimates his family’s medical premiums and out-of-pocket expenses to be $30,000 per year.
At the advice of his CPA and a qualified plan administrator, he sets up a stand-alone one-person HRA. The plan administrator ensures the plan is set up to follow Department of Labor and IRS regulations. He sets the contribution limit to be $30,000 per year. After searching through the marketplace, he finds a plan that he feels will be suitable to his and his family’s needs. He purchases the plan and submits his qualified receipts on a timely basis to the plan administrator throughout the year.
At the end of the year, Alex has used the entire $30,000 contribution and ABC Corporation has $250,000 of earnings. Alex earned a regular salary during the year of $75,000. Using this information, we can calculate ABC Corporation’s taxable income below:
- $250,000 earnings
- ($75,000) W-2 earnings to Alex
- ($30,000) HRA contributions
- $145,000 taxable income
Under the Tax Cuts and Jobs Act, tax rates for corporations were lowered to a flat amount of 21%. Thus, ABC’s tax due is $30,450. Alex’s wife does not work, so she has no taxable income. Therefore, Alex’s income is taxed in the 12% bracket, for a total expense of $9,000. The contribution he received is completely tax-free to both the corporation and him.
Had Alex not elected the Section 105 plan, he would have had to pay for his health expenses using after-tax dollars, and would only have been able to itemize them, not deduct them directly, for amounts exceeding his AGI above 10%. Let’s compare.
For ABC Corporation, taxable income would be $175,000:
- $250,000 earnings
- ($75,000) W-2 earnings to Alex
- $175,000 taxable income
The tax due for ABC Corporation would be $36,750. Alex would have the salary of $75,000 to include on his W-2. However, his family’s health care expenses would be paid with after-tax dollars and would only be deductible on their 1040 to the extent that they exceed 10% of his AGI.
Therefore, $22,500 would be deductible from taxable income ($75,000 AGI x 10% = $7,500 minimum expense; $30,000 total medical expenses – $7,500 cap = $22,500 deduction from taxable income). His final taxable income would be $52,500 at a rate of 12%, or $6,300.
Clearly it is beneficial for Alex to adopt the Section 105 plan. It increases the amount of income available to spend on his family for their day-to-day expenses, and decreases the amount of tax owed by ABC Corporation by $6,300 for the year.