How to deduct 100% of health-care costs

Nation's Business, May, 1997 by Stephen Blakeley

If you're self-employed and married, there's a little-known but fully legal way for you to deduct 100 percent of your medical costs.

The technique involves Section 105 of the tax code, which governs accident- and health-insurance plans and allows certain self-employed workers to write off all medical costs as business expenses. These costs include insurance premiums and uninsured expenses such as copayments, prescription drugs, and dental and eye care.

By comparison, the standard healthcare deduction for the self-employed is only 40 percent of costs.

The key is to hire your spouse as a salaried, bona fide employee. You then can create a Section 105 benefits package that provides the employee with family medical coverage (covering husband, wife, and children). That permits the business owner to deduct the full cost of the family's health care, including uninsured medical costs, as a business expense.

"Section 105 has been around for a long time. It has been tested under [Internal Revenue Service] audit, and it has been upheld," says Gene Fairbrother, a financial consultant to the National Association for the Self-Employed (NASE) in Washington, D.C. But he adds that "some businesses have lost [IRS audits] because they did not have a specific written [Section 105] plan, and they didn't keep receipts You have to have substantiation."

The IRS agrees. "It is true that you can do this, but there are a lot of pitfalls," warns Jodi Patterson, an IRS spokeswoman. "The bottom line, from our perspective, is that a person who's going to do this should be very careful that they faD within this situation. They should check with a tax attorney."

The nation's largest administrator of Section 105 plans is AgriPlan/BizPlan, a Madison, Wis., firm that charges $175 a year to set up a plan and handle the paperwork. The firm, which provides the services to members of 18 state chapters of the American Farm Bureau in addition to other small businesses, says that last year it put together Section 105 plans for 40,000 small-business owners--including farmers--who had an average tax savings of $1,800.

BizPlan is so confident that its technique complies with IRS rules that it offers customers a guarantee that they will pass an IRS audit "if all procedures are adhered to."

BizPlan notes that owners of larger firms can also establish Section 105 plans but that the plans work best for husband-and-wife operations. Because all employees must be offered the same benefits, Section 105 plans can become prohibitively expensive if there are a number of employees in addition to the spouse.