Health Plans for Small Business Owners
If you're a small business owner, you're in a tough bind. You have a responsibility to yourself and your family. Yet you're understandably fearful about committing a lot of scarce resources, especially when it can cost you an extra 40 percent of an employee's salary to insure him or her. But you do have some choices.
Flexible Spending Accounts
A flexible spending account (FSA), also known as a Section 125 plan, or “cafeteria plan,” allows you to use the full dollar when you pay out-of-pocket medical expenses. Each year, the amount that an employee wants to put in the FSA is divided by the number of pay periods in the year and taken out of each check before taxes.
FSAs cover fees like co-payments, as well as a wide variety of non-traditional expenses like chiropractor or acupuncture fees and daycare. It also reduces employees' pre-tax salary at the same time, decreasing tax liability. But if an employee leaves the company, any medical expense incurred after he or she leaves is ineligible for reimbursement.
That's because employers fund the plan all at once at the beginning of the year and employees “earn back” the cash over the course of the year. But employers are protected by the use it or lose it law, where the unused money in the FSA fund reverts back to them if employees fail to use up their allotments by the end of the year.
Archer Medical Savings Accounts
The Archer medical savings account (MSA) combines a tax-free savings and investment account with a high-deductible health insurance policy that provides complete coverage. These plans are only available to companies with 50 or fewer workers.
Essentially, any money you put into the account is exempt from withholding and taxes. The money compounds tax-free. You can take it out, also tax-free, for qualified medical expenses.
First, you need to establish a health insurance policy with a high deductible, which has been defined as between $3,000 and $4,500 for a family and at least $1,500 and no more than $2,250 for an individual.
If you currently pay $800 a month for HMO coverage for your family, a high-deductible plan will usually cost you about half as much. Then, you can fund your MSA with the difference to cover the small medical bills.
It might seem like you and your family could be exposed for several thousand dollars in medical costs, but 70 percent of Americans don't even meet or exceed $500 in medical expenses in a year. If a catastrophe occurs, you already have coverage through the high-deductible insurance plan you opened to fund the MSA.
When you need the money, you can take it out, tax-free, by check or ATM. And you can roll over whatever money that is left, tax-free, into the next year. MSAs are portable, so they stay with you, not the company. In addition, you have more freedom of choice in selecting health care providers, because you don't have an HMO's out of network restrictions.
The Section 105 Plan
Section 105 plans work best for unincorporated businesses like sole proprietorships, partnerships, or limited liability companies, or for the self-employed. You can deduct 100 percent of your health insurance premiums and out-of-pocket traditional and non-traditional medical expenses on your IRS Schedule C.
If you're married, Section 105 is even better. Hire your spouse as a part-time employee to provide bona fide, documentable help to your business, at a salary that equals his or her health plan costs. Pay him or her any more, and you may be hit with payroll taxes.
You can deduct the costs for the insurance as a business expense, and your spouse doesn't get taxed. Then, because the plan covers your spouse's family, you're covered as well.
However, Section 105 reduces your taxable income and, therefore, your Social Security contributions. This can result in lower retirement savings. You could buy a universal life insurance policy to compensate for the lower survivor benefits of your Social Security payout.
Be sure to ask your tax advisor to help you set this up. If the IRS determines that your plan is non-compliant, you will most likely be liable for back taxes and penalties.