What is Section 105?What is Section 105?

The Question

Large corporations candeduct 100 percent

of medical expenses.

The Idea

Why can’t familyfarmers and small business owners?

The Solution

Section 105

Levels the Playing Field!

Objectives

• What is Section 105?

• Who Qualifies?

• Calculating Tax Savings

• Choosing an Administrator

IRC Section 105(b) Amounts expended for medical care. Except in the case of amounts attributable to deductions under Section 213, gross income does not include amounts referred to in subsection (a), if such amounts are paid directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses incurred by him for medical care as defined by Section 213(d) of the taxpayer, his spouse, and his dependents as defined by Section 152.

Breaking the Code

• Section 105 is a 1954 tax law that allows for family employment. In addition is tied to IRC Sections 79, 106, 162; and to Revenue Ruling 71-588 and is supported by Letter Ruling 9409006.

The Basic Concept

• Cash Wage

• Employee Benefits

• Tax Deductible

• Tax Free

very simple

Available BenefitsHealth Related

Insurance Premiums

Non-Insured Medical Expenses

(Out of Pocket Expenses)

Long-Term Care Premiums

Term Life and Disability Insurance

Premiums

Eligible Expenses

AcupunctureAlcoholismAmbulance hireArtificial limbs/teethBirth control pillsBirth prevention surgeryBracesBraille - books and magazinesCare for handicapped childChiropractorsChristian Science feesCo-insurance Communication equipment/deafContact lenses and cleaning solution

DeductiblesDental feesDenturesDiagnostic feesDrug and medical suppliesEducation for the blindEyeglasses, including exam feeHealing service feeHearing devices and batteriesHome improvements motivated bymedical consideration.Hospital bills/hospitalization insuranceInsulin

Laboratory feesLaetrile by prescriptionLead-base paint removal for children with lead poisoningMembership fee in association with furnishing medical services, hospitalization, and clinical careNeeded medical supplies, prescribed by doctorNurses’ feesObstetrical expensesOperationsHospital Expenses

Eligible Expenses

InsuranceInsulinLaboratory feesLaetrile by prescriptionLead-base paint removal Membership fees Needed medical suppliesNurses’ feesObstetrical expensesOperationsOrthodontiaOrthopedic shoesOsteopathsOxygenPrescribed medicines (includingover-the-counter)

Psychiatric carePsychologist feesRoutine physicals and othernon-diagnostic services and treatments“Seeing Eye” dog and its upkeep Sterilization feesSurgical feesTherapeutic care for drug/alcohol addictionTherapy treatmentsTransportation expenses primarily forrendition of medical services

Tuition at special school for handicappedWheelchairWigs (prescribed by a physician)X-rays

Did I Mention Over the Counter?

• Allergy Prevention and Treatment• Antacids and Acid Reducers• Anti-histamines• Anti-diarrheal and Laxatives• Anti-itch lotions and creams• Cold Sore/Fever Blister• Cough Suppressants• Decongestant• Cold Remedies• First Aid Supplies• Migraine

The Players

Plan Administrator

Financial Professional

Spouse-Employer

Spouse-Employee

Financial Professional

1. Inform qualified clients ofthis tax savings opportunity.

2. Tax Forms: SS-4, I-9, W-2, W-3, W-4, 941/943

3. Annual Consultation and Review

Client Responsibilities

6 Steps to Savings!

1. Enroll

2. Employ

3. Establish

4. Reimburse

5. Review

6. Renew

Clients Responsibility

1. Enroll with Administrator

2. Employ Spouse

3. Establish Compensation Package– Pay wages monthly or quarterly– Fringe Benefits

• Health, Dental & Long-Term Care Insurance

• Out of Pocket Medical Expenses• Term Life, Disability Insurance

Client Responsibility, Cont’d

4. Reimburse Medical Expenses

5. Submit Benefit Expenses Annually

6. Renew Benefits Annually

Step 1:Step 1: Enroll with Administrator

Can’t I do this myself?

What if I have other employees?

It seems complicated?

Step 1:Step 1: DOL Guidelines (Eliminate not Discriminate)

• Part Time (Max of 25 hours)

• Seasonal Employee (Max 7 months)

• Employees Age (Max 25 years old)

• Current Employees (Max 36 months)

• New Employees (Max 36 months)

Step 2:Step 2: Employing Spouse

Need to create a bonafide employer-employee relationship

Step 3: Establish Benefits & Compensation

W-2 Wage

Benefits

Insurance

Out of Pocket

Long Term Care

Life Insurance

Total

“Reasonable”

Compensation

What is Reasonable Compensation?

Total Benefits

+Total W-2

Wage =Total Comp

Total Comp

÷Number of Hours Worked

=Hourly Wage

Is the Hourly Wage Reasonable for duties, location, tenure?

Example 11.1. What are your health expenses?

-Health Insurance = $12,000

-Out of Pocket = $5,000

Total Expenses = $17,000 2.2. Calculating W-2 Wage

-Total Expenses = $17,000

-% Multiplier (i.e. 25%) = $4,250

Total W-2 Wage = $4,250

Example 1, Cont’d

3.3. Calculating Total Compensation

-Total Expenses = $17,000

-Total W-2 Wage = $4,250

Total Compensation = $21,250

4.4. Calculating Hourly Wage

-Number of Annual Hours = 1080

-Total Comp ÷ Hours = $19.67

Hourly Wage = $19.67

Example 1, Concluded

5.5. Duties, responsibilities and reasonableness

Is Hourly Wage $19.67 reasonable?

Yes or No?

Why or Why Not?

Is the Hourly Wage Reasonable for duties, location, tenure?

What if you had to advertise for this position what would you have to pay to get someone to do the same work?

Step 3: Establish Plan

• Payroll Component– Paycheck Processing– Quarterly or Annual Tax Filings– W-2 Processing

• Weekly, Monthly, Quarterly

• Easy to outsource!

Step 4:Step 4: Reimburse for Expenses

Spouse-Employer

Spouse-Employee

Provider Office, Pharmacy etc

Serv

ice R

en

dere

d/P

aym

en

t M

ad

e

Receipts Submitted

Expenses Reimbursed

Employer Must “Reimburse” Employee and not pay Provider

directly!

Step 5:Step 5: Review Reimbursements

• Year End Process– Tally Reimbursement– Review Eligibility– Take Deduction!– Retain Receipts

Step 6:Step 6: Review Plan Design

• Review Plan Design– Employee Eligibility– Benefits and Maximums– Carryover Balance– Reasonable Compensation– Return on Investment

What is Carryover?

• IRS allows Section 105 Plans to “carry over” unused medical expenses (out of pocket) up to a pre-determined maximum

Carryover Example

2006

OOP Maximum = $5,000

Used OOP = $2,500

2007

OOP Maximum = $5,000

Carryover Bal = $2,500

Total Available = $7,000

By implementing a Carryover you can have unused funds in one year cover years where expenses were more than expected without changing Reasonable Compensation calculations!

Who Qualifies?

• Small Businesses and Farmers who can declare the following employment criteria– Legitimate employment

• employee who receives a W-2 wage.

– Necessary duties • employee who performs necessary duties for the

company.

– Reasonable compensation • compensation to the employee that is reasonable

for the type of duties he or she performs.

Comparison

Managed By

Income Taxes

Can Owner Part. in EE Benefits?

Sole-P Proprietor Pass Through

No

Partnership Partners Pass Through

No

LLP Partners Pass Through

No

LLC-Inc Members Separate Yes

C-Corp Board Separate Yes

S-Corp Board Pass Through

Limited

Non-Profit Members or Trustees

-- Yes

In Other Words…

• Small Businesses and Farmers who file tax forms Schedule C, F or corporate tax forms.

What are We Doing?

Income – Expenses = Taxable Income

Taxable Income x Tax Rate = Taxes Payable

Goal of Individuals & Businesses = Reduce Taxes Payable by wisely increasing allowable Expenses

Can’t I Already Do This?

• Schedule A?

• Deductibility of Health Insurance?

• Health Savings Account?

Schedule A

• Itemized (Schedule A) is a variable deduction amount based on your individual expenses for the tax year

• Deduction ExamplesReported on Schedule A– Medical & Dental Expenses– Property Taxes– Mortgage Interest– Charitable Gifts

Schedule A Cont’d

• Under Schedule A can include Medical & Dental Expenses

• EXCEPTION! – Medical expenditures must be greater than 7.5% of Adjusted Gross Income (AGI) in order to claim benefit and then you can only take the difference!

Example 1

• $62,000 Adjusted Gross Income (AGI = I – E)

• $3,200 in Medical Expenses

• Multiply $62,000 by 7.5% = $4,650• If answer = more than total Medical

Expenses, the allowable deduction is -0-

With Section 105 the Medical Deduction would be $3,200 filing under the Schedule C!

Example 2

• $62,000 Adjusted Gross Income • $10,000 in Medical Expenses

• $62,000 * 7.5% = $4,650• $10,000 - $4,650 = $5,350 Medical Deduction

With Section 105 the Medical Deduction would be $10,000 filing under

the Schedule C!

If Not “A”, Then “HSA”?

• Pros of HSA– No Marriage

Restrictions– IRA Rollover

• Cons of HSA– Restrictions on

Coverage Options– Required to be

Pre-Funded– No Self

Employment Tax Savings

– Limited Compliance Assistance

Federal Deductibility?

• Clinton Administration signed in 100% Federal Deductibility of Health Insurance Premiums– Added lines to Federal Tax forms

related to Medical expenses

• Does not include State or Self-Employment taxes!

Comparison

Without Section 105

Premium Deduction 100%$4,000 x 100% = $4,000Federal Tax Rate $4,000 x 15% = $ 600Tax Savings = $ 600

Non-Insured Expenses 0%$3,000 x 0% = $ 0Federal & State TaxTax Savings = $ 0

Total Expenses = $7,000Total Deduction = $4,000

Total Tax Savings $600

With Section 105

Premium Deduction 100%$4,000 x 100% = $4,000Federal, State & SE Tax Rate$4,000 x 35% = $1,400Tax Savings = $ 1,400

Non-Insured Expenses 100%$3,000 x 100% = $3,000Federal, State & SE Tax 35%Tax Savings $1,050

Total Expenses $7,000Total Deduction $7,000

Total Tax Savings$2,450

Then What?

• Itemized on business Schedules– Schedule C for “Company” – Schedule F for “Farmer”

Deduction ExamplesReported on Schedule C/F

• Car & Truck Expenses

• Mortgage• Rent or Lease• Legal &

Professional Services*

• Repairs & Maintenance

• Depreciation• Employee Benefit

Programs*• Pension & Profit

Sharing Plan

*Section 105 deductions falls under these

categories

How Self-Employment Tax is Impacted

• What is Self-Employment (SE) Tax?– Equivalent to FICA on W2 Wages (Employee

pays 7.65% of gross wage and employer matches 7.65%)

– Must be paid if earnings are more than $400

• This tax equals 15.3% (FICA multiplied by 2) of Net Profit or Loss from Schedule C/F

Self Employment Tax Cont’d

• Because the Net Profit (Loss) has been reduced by AgriPlan/BizPlan the Self-Employment tax payable will also be reduced, increasing the total amount of savings.

Deciphering Tax Forms

• Individuals– 1040– Schedule A (only if

choosing to itemize)

• Individuals who own Businesses– 1040– Schedule A– Schedule C and/or F– Schedule SE

Form 1040

• Line 12 Schedule C Income or (Loss)

• Line 18 Schedule F Income or (Loss)

• Line 31 – Self-Employed Health Insurance Deduction *Common Misconception to Use this Line!*

• Adjusted Gross Income (AGI)

Schedule C

• Line 14 Employee Benefit Programs (Medical Expenses Reimbursed to Employees under AB)

• Line 17 Legal & Professional Services (AB Administration Fee)

Schedule F

• Line 17 Employee Benefit Programs (Medical Expenses Reimbursed to Employees under AB)

• Line 34 Other Expenses (AB Administration Fee)

Schedule A

• Lines 1-4 Medical and Dental Expenses

• Lines Would not be used if AgriPlan/BizPlan Client amounts would be calculated on Schedule C/F

105 with Tax Filing Status

• AgriPlan and BizPlan works with all filing structures

• Spousal Employment is required for some

• See comparison chart…

Federal Individual Tax Rate

Taxable Income* Rate*

$0 $14,600 10%

$14,600 $59,400 15%

$59,401 $119,950 25%

$119,951 182,800 28%

$182,801 $326,450 33%

$326,450 Over 35%

*Indexed 2005

Federal Corporate Tax Rate

Taxable Income* Rate*

$0 $50,000 15%

$50,000 $75,000 25%

$75,000 $100,000 34%

$100,000 $335,000 39%

$335,000 $10,000,000 34%

$10,000,000 $15,000,000 35%

$15,000,000 $18,333,333 38%

$18,333,333 Over 35%

*Indexed 2005

Determine Your Personal Tax Savings

This illustration assumes an average state tax of 5% and a 15.3% FICA rate when calculating your multiplier. Actual savings may vary.

2. Determine your multiplier:

If your taxable income is:0-14,000

14,001-56,80056,801-114,650

114,651-174,700174,701-311,950

311,951 +

Your Federal Tax is:

10%15%25%28%33%35%

Your Multiplier is:

.30

.35

.45

.48

.53

.55

__________________ x __________________ = __________________

3. Determine your tax savings:

Enter # from A Your multiplier TOTAL TAX SAVINGS

1. Add together the following:

Family Medical & Long-Term Care Insurance Premiums:

Family Non-Insured Medical Expenses:

Total Tax Deductible Expenses: (A)

Let’s ReviewHealth Insurance = $ 6,000

Non-Insured Expenses = $ 4,000

W-2 Wage = $ 3,000

Total Compensation = $13,000

Tax SavingsReimbursed Medical Expenses $10,000

Federal Tax x 15%

State Tax x 5%

Self Employment Tax x 15%

Total Tax Saving = $3,500

Period of Coverage

• Period of Coverage applies if first Plan Year begins Mid-Year

Example:

March 14th Enrolled in Section 105 Plan

Premiums January 1st

Out of Pocket Expenses March 1st

Choosy Professionals Choose TASC

• Plan Document

• Adoption Agreement

• Summary Plan

Description

• Claims Review

• Re-election of

Benefits

• Renewal

• Audit Guarantee

• Year-round, toll-free

assistance

• Tax Savings

Guarantee

The Bottom Line

100% Deductibility

Worry Free Administration

Audit Guarantee

Tax Savings = $2,450

Less than $200 a year!

Tax Awareness vs. Tax Avoidance

I live in Alexandria Va. Near the Supreme Court chambers is a toll bridge across the Potomac. When I rush, I pay the dollar toll and get home early. However, I usually drive outside the downtown section of the city and across the Potomac on a free bridge.

This bridge was placed outside the downtown Washing ton D.C. area to serve a useful social service – getting drivers to drive the extra mile and help alleviate congestion during the rush hour.

If I went over the toll bridge and through the barrier without paying the toll, I would be committing tax evasion.

If, however, I drive the extra mile and drive outside the city of Washington to the free bridge, I am using a legitimate, logical and suitable method of tax avoidance and I am performing a useful social service by doing so.

For my tax evasion I should be punished. For my tax avoidance I should be commended. The tragedy of life today is that so few people know that the free bridge exists.

Justice Louis D. Brandeis