We have long discussed the benefits of section 105 plans. But once you have set one up how is it deducted on your tax return? We will take a look at how to deduct it for various entity structures.
Section 105 expenses are classified on the tax return according to the type of legal structure the company falls under. Business owners should work with their tax professionals to ensure that they are classified in the proper manner.
Sole Proprietorships
Sole proprietorships who qualify for Section 105 plans by employing a spouse or family member may include the expense in line 14 of Schedule C (Profit or Loss from Business). In accordance with labor and tax regulations, the reimbursement expense must be paid directly to the employee, and the employee must in turn cover the sole proprietor on the insurance policy in order for this to be deductible from taxable income of the business.
In turn, the reimbursement expense will appear on the employee’s W-2 as non-taxable fringe benefits, generally in box 12 FF. These amounts are excluded from the employees’ taxable income.
Owners of sole proprietorships with no employees do not qualify for the Section 105 tax-free treatment of medical expense deduction. Instead, they can include the cost of their medical plans in line 29 of Form 1040. However, they are still subject to the 15.3% self-employment tax on these expenses.
Partnership
Partnerships who qualify for Section 105 plans by employing a spouse or family member may include the expense in line 19 of form 1065. This expense is directly deducted from the business’ taxable income that is divided into each partner’s K-1 tax form.
However, partners who do not qualify for Section 105 treatment must include any payments for health insurance premiums that are made by the business in the “Guaranteed Payments” section of form 1065. This amount is then included in taxable income to the partner, but can be deducted in line 29 of Form 1040. Similar to a sole proprietorship, it is still subject to the 15.3% self-employment tax.
S-Corporation
S-Corporations are eligible to set up Section 105 plans but cannot claim tax-free exemptions that sole proprietorships or partnerships can if they have family members who work for the company. Instead, the payments for shareholder health insurance premiums and reimbursements that are made through the company appear on 1120-S under item 1b) Returns and allowances.
These payments are taxable income to the business owner. However, payments made for group health employee benefits to employees who are not classified as shareholders can be deducted directly from taxable income in line 18.
Similar to sole proprietorships and partnerships, the premiums and medical reimbursements made can be deducted on Form 1040 line 29. It is still subject to the 15.3% self-employment tax.
C-Corporation
C-Corporations file Form 1120 and may deduct the full cost of health insurance premiums for both owners and employees on line 24, Employment benefit programs. C-corporations enjoy the tax-free benefits of Section 105 plans and are not subject to some of the limitations on individual reimbursements that sole proprietorships, partnerships and S-Corps are. 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.
| Entity Type | How Expenses Are Reported | Where to Report |
|---|---|---|
| S‑Corporation | Reimbursements to employee‑owners (including minors >2% shareholders) are wages and deductible business expenses. | Included in ordinary business expense deductions on Form 1120‑S, reducing pass‑through income. (section105plan.com) |
| Partnership / LLC | If employing a spouse or family member legitimately, reimbursed Section 105 expenses are treated as guaranteed payments. | Reported as guaranteed payments on Line 19 of Form 1065 and included in K‑1 distributions. (section105plan.com) |
| C‑Corporation | Owner‑employees fully participate; reimbursements are tax‑free income to employees and fully deductible business expenses. | Deducted on Form 1120 as ordinary compensation expense. (section105plan.com, section105plan.com) |
| Sole Proprietor | A sole proprietor cannot reimburse themselves directly tax‑free. Instead, they must employ their spouse, who receives tax‑free reimbursement with them as a dependent. | Reimbursements are reported on Schedule C—Line 14 (Other expenses) of Form 1040. (section105plan.com, section105plan.com) |
