Subscriber Training Welfare Benefit Plans
Welcome Brief Overview of 105 Concepts What’s New? Audit GuaranteeCourt Cases Sub S Corporation ReviewBenefit Plans Web Application Training Enrolling a New Employer Year End Plan Management
What’s New with 105 Concepts? • New Product Development • New HRA Product • Section 125 Plans • Combination Plans • Spring of 2008
Audit Guarantee • 105 Concepts Audit Guarantee • Reality of an Audit Guarantee • Your Control • Documents • Basic Plan Operation and consultation • Employer’s Control • Employer/employee Relationship • Reimbursement of Medical Expenses • Hours worked, wages paid
Audit Guarantee 105 Concepts has created a web-based application for the exclusive use of 105 Concepts’ subscribers for the creation and facilitation of Health Reimbursement Arrangements (HRA). 105 Concepts allows this creation and facilitation through the online Plan Administration Center and is not considered a Third-Party Administrator. Unless otherwise agreed upon, year-end claim reviews and substantiation are the responsibility of the subscriber, on behalf of their clients.
Audit Guarantee 105 Concepts offers an audit guarantee on all plan documents generated by the 105 Concepts Plan Administration Center. Additionally, if an enrolled business-owner is operating a 105 Concepts-generated plan under the instruction of their tax professional, and the tax professional assists them in operating within the guidelines of IRS Publication 502 and other pertaining IRS guidelines, 105 Concepts will extend the audit guarantee to cover plan operation.
Audit Guarantee At such time, 105 Concepts guarantees to pay any and all fines, penalties, and interest amounts which have been levied against the enrolled business-owner due to legitimate plan use. The taxes owed will remain the responsibility of the business-owner using the plan. If the business-owner and/or the tax professional have operated outside of the guidelines, then the audit guarantee pertaining to the operation of the plan will be void.
Court Cases T.C. Memo 2007-144: Darwin J. Albers & Peggy L. Albers, Petitioners v. IRS T.C. Memo 2007-351: Ralph E. Frahm & Erika C. Frahm, Petitioners v. IRS In the first case (Albers), Darwin Albers is a farmer who employed his wife, Peggy, to work on his farm. He completed the proper paperwork, including a spousal employment agreement, to establish a 105 Plan for her benefit. Peggy Albers performed the services for the farming business as provided for in the employment agreement. As medical expenses were incurred, Darwin Albers paid most of these expenses directly from the joint checking account that was also used to pay farm expenses and Peggy’s wages.
Court Cases Darwin Albers purchased a health insurance policy that would cover himself, his wife, and their dependent children. On the policy, Darwin Albers listed himself as the “Applicant”, with Peggy Albers as “spouse”. In other words, the insurance policy was in Darwin Albers’ name. The premiums for this policy were paid from the joint account. It does not appear that there was any evidence submitted to show that Darwin Albers wrote checks to Peggy Albers to reimburse her for any of these expenses. At one point, Peggy Albers charged $854 of medical expenses on her credit card, but there was nothing to show who paid the charge or if any reimbursement was made to Peggy for the charge.
Court Cases Let’s now jump to the second case (Frahm) and look at the facts in that case. Ralph Frahm is a farmer who employed his wife, Erika, to work on his farm. He, too, completed the proper paperwork, including a spousal employment agreement, to establish a 105 Plan for her benefit. They kept records of the work that Erika Frahm performed in her capacity as an employee. As medical expenses were incurred, Erika Frahm paid the expenses from her individual checking account. Ralph Frahm, as employer, issued checks from a joint business checking account to Erika Frahm to reimburse her for the medical expenses that she had paid.
Court Cases Ralph Frahm purchased a health insurance policy that would cover himself and his wife. On the policy, Ralph Frahm listed himself as the “Applicant”, with Erika Frahm as “spouse”. So just like in the Albers case, the health insurance policy was in the farmer’s name. Unlike in the Albers case, Erika Frahm paid the premiums for the health insurance policy from her individual checking account. Ralph Frahm then wrote checks from the joint business account to Erika Frahm to reimburse her for the health insurance premiums paid.
Court Cases In the Albers case, the judge ruled that the Petitioners “…failed to establish that her employer Mr. Albers paid, directly or indirectly, to Ms. Albers pursuant to the …. medical reimbursement plan the claimed…….health insurance premiums and the claimed……medical and dental expenses….” The decision also determined that the petitioners failed to establish that the expenses were ordinary and necessary – in other words, that they were legitimately paid as part of an employee benefit plan. Judge Chiechi decided in favor of the respondent (IRS).
Court Cases • In the Frahm case, Judge Chiechi decided in favor of the Petitioners – the Frahm’s. • It is evident that the differences in the operations of the Plans determined the outcomes in these two cases. It did not matter that the insurance policy was in the Employer’s name (the farmer) as that fact was the same in both cases. The determining factor was the paper trail. Since these are reimbursement plans, it is imperative that the Employee covered by the Plan pay the medical expenses for him or herself, their spouse, and dependents. The Employer must then write a check to his/her employee and reimburse him/her for that expense. By performing these transactions, the taxpayers create the evidence to show that the Plan exists as a legitimate fringe benefit plan created as part of a compensation arrangement for the benefit of the employee.
Sub S Corporation Review • In May 2006, the IRS issued their Headliner 163 regarding S Corporations and the deductibility of health insurance premiums • Prior to this, most accountants would deduct the premiums in the S Corp, add them back into wages for a greater than 2% shareholder, then subtract them on the face of the Form 1040 as self-employed health insurance premiums.
IRS Headliner 163 • What is a Headliner? • Helpful Hints • What it isn’t: • Not a Regulation • Not a Revenue Procedure • Not a Revenue Ruling • Not a Technical Advice Memorandum
In many solely owned businesses, the owner of the business will purchase health insurance in his or her own name versus the name of the business. The type of entity may greatly affect where this insurance premium expense may be deducted on the individual’s personal income tax return. Headliner 163
Headliner 163 In Chief Counsel Advice (CCA) 200524001, it was held that a self-employed individual who is a sole proprietor and who purchases health insurance in his or her own name may treat that as health insurance purchased in the name of the sole proprietor business. As such, the insurance would qualify under the provisions of IRC §162(l). Assuming the self-employed individual meets the other provisions of IRC §162(l), the individual may claim a deduction for the insurance premiums in arriving at his or her adjusted gross income; also referred to as an above-the-line deduction.
Headliner 163 In contrast, if the business is operating as an S corporation, there is a different tax consequence if the individual who is the sole shareholder and sole employee, purchases the health insurance in his or her own name.
Headliner 163 For certain fringe benefits paid by the S corporation, including health insurance premiums, the Internal Revenue Code (IRC) holds that the S corporation will be treated as a partnership and any shareholder who owns more than 2% (a 2% shareholder) of the S corporation stock will be treated as a partner of such partnership (IRC §1372(a)). Revenue Ruling 91-26 holds that accident and health insurance premiums paid by a partnership on behalf of a partner are guaranteed payments under §707(c) of the Code if the premiums are paid for services rendered in the capacity of a partner and to the extent the premiums are determined without regard to partnership income. As guaranteed payments, the premiums are deductible by the partnership under §162 (subject to the capitalization rules of §263) and includible in the recipient-partner's gross income under §61.
Headliner 163 As such, the health insurance premiums paid by the S corporation would not be deductible by the S corporation as a fringe benefit but would be deductible by the S corporation as compensation to the 2% shareholder. The health insurance premiums paid by the S corporation for the 2% shareholder should be included in the 2% shareholder’s W-2.
Headliner 163 IRC §162(l)(5) holds that a 2% shareholder that is treated as a partner under IRC §1372 will be treated as a self-employed person and, assuming all of the other provisions of IRC §162(l) are met, may deduct the health insurance premiums paid by the S corporation as an above-the-line deduction. It should be remembered that there are some limitations under IRC §162(l)(2). The one that often affects a 2% shareholder deals with other coverage. An above-the-line deduction is not allowed for any calendar month for which the shareholder is eligible to participate in any subsidized health plan maintained by any other employer of the shareholder or of the spouse of the shareholder.
Headliner 163 Assuming there are no other subsidized health plans, the problem arises if the sole shareholder/ employee purchases the health insurance in his or her own name instead of that of the S corporation. In that case, the S corporation has not established a plan to provide medical care coverage, there is no fringe benefit paid to the 2% shareholder and the provisions of IRC §1372 do not come into play. Since the provisions of §1372 do not come into play, the S corporation is not treated as a partnership and the shareholder is not treated as a partner. Since the shareholder is not treated as a partner, the shareholder is not treated as self-employed and is not eligible for the above-the-line deduction treatment under IRC §162(l). The shareholder is still able to deduct the health insurance as an itemized deduction which is subject to the 7.5% AGI limitation.
Headliner 163 Some states do not allow a corporation to purchase a group health plan with only one participant. This prevents the S corporation from acquiring a health plan and it requires the shareholder to purchase the plan in his or her own name. That state law limitation does not override the requirements that the S corporation must provide fringe benefits to its employees in order to have the 2% shareholder qualify for the IRC §162(l) benefits.
Headliner 163 In summary, contrary to the holding in CCA 200524001 dealing with a sole proprietorship, a shareholder/employee is not allowed to purchase health insurance in the shareholder’s own name and still obtain the above-the-line deduction benefits of IRC §162(l).
IRS Headliner 163 • Three Options: • Ignore it and continue to take an above the line deduction for the health insurance premiums. • Agree with it and no longer take an above the line deduction for the health insurance premiums. • Implement an HRA and take an above the line deduction for the health insurance premiums.
Comments and Analysis • The key language here is that “…the S Corporation has not established a plan to provide medical care coverage...”. • By establishing an HRA, the S Corporation is in fact establishing a plan. • The plan is a fringe benefit paid to the 2% shareholder. • The provisions of Section 1372 apply.
IRS Headliner 41 The IRS would like to clarify the proper reporting of S corporation payments of health and accident insurance premiums made on behalf of its greater than 2% shareholder-employees continues in the manner reflected in Revenue Ruling 91-26, 1991-1 CB 184, as clarified in IRS Announcement 92-16, 1992-5 IRB 53.
IRS Headliner 41 The cost of these health and accident insurance premiums paid on behalf of the greater than 2% S corporation shareholder-employee (hereafter referred to as “shareholder”) is deductible by the S corporation and reportable as additional compensation to the shareholder.
IRS Headliner 41 This additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement issued to the shareholder. If these payments are made under a “plan” for the S corporation employees and their dependents, the amount would only be subject to income tax withholding, and would not be included in Boxes 3 or 5 of Form W-2 wages for Social Security or Medicare, nor would it be subject to the FUTA tax.
IRS Headliner 41 Form K-1 (1120S) and Form 1099 should not be used as an alternative to the Form W-2 to report this additional compensation. The payments of the health and accident insurance premiums on behalf of the shareholder may be further identified in Box 14 (Other) of the Form W-2.
Overview • What is an HRA? • Must be a written plan • Funded by the employer • Reimburses qualified medical expenses • Reimbursement maximum must be established • Subject to non-discrimination requirements • Can carryover unused benefits to subsequent years
Overview • Employer establishes the HRA • Employee submits qualified medical expense • Only expenses incurred after the date the plan is implemented can be reimbursed. • Employer reimburses amount paid • Verifies the expense and keeps the records.
Consumers Have a Choice Consumers Choice Health Care is here to stay: Medical expenses continue to be the big discussion with businesses in America. Employers experiment with ways to find the perfect match between a group health plan and a welfare benefit plan.
The Future One way, and right now the only way, to help offset the rising cost of medical care is to offer benefit plans that fill the gap between deductibles and co-pays. Employers are raising deductibles and co-pays at a frantic pace just to keep up with rate increases. The employer with fewer than 99 employees is effected by health care costs the most. Simply put, they do not have the number of employees to spread the risk around.
Objective 1. Present you with a general knowledge or “feel” for the small employer market. 2. Share basic principals of Consumers Choice Health Care. Health Savings Accounts Limited Purpose HRAs (HSA and HRA)
Why do you need to know? The Consumers Choice Health Care market is expanding at a rapid pace: New products, services, and companies are showing up everywhere. Most of them package specific products with different options taking away the flexibility for plan design.
Why do you need to know? As tax professionals your small business clients turn to you for council and advice. If you have an understanding of Consumers Choice Health Care in today’s market, imagine what you could do for your clients now and into the future.
Understanding Consumers Choice In order to understand where Consumers Choice Health Care is going you need to understand how it came about.
The Past: 100% Co-Pays and Deductibles Employer’s bought health plans with low deductibles and co-pays. Health Insurance Plans paid for everything. This meant: People went to the doctor for every little thing Doctors and Hospitals charged more Prescription Drug Companies used and still use direct marketing
The Present Medical Plans are expensive: In order to fight the rising cost, employers purchase plans that cover less. The employee has more out pocket expenses then ever before.
The Present More and more employers are turning their attention to fringe benefit plans such as: Flexible Spending Accounts Health Reimbursement Arrangements Health Savings Accounts
The Present I like to refer to these fringe benefits as: Wrap around or gap benefit plans
As a Tax Professional In the next 5-10 years: Health Savings Accounts and Health Reimbursement Arrangements will be the benefits of choice. The more familiar you become with these benefit plans the better you will be able to serve your small business clients.
What is an HRA? An HRA is an arrangement that: (1) is paid for solely by the employer and not provided pursuant to salary reduction election or otherwise under a §125 cafeteria plan; (2) reimburses the employee for medical care expenses (as defined by § 213(d) of the Internal Revenue Code) incurred by the employee and the employee’s spouse and dependents (as defined in § 152); (3) provides reimbursements up to a maximum dollar amount for a coverage period and any unused portion of the maximum dollar amount at the end of a coverage period is carried forward to increase the maximum reimbursement amount in subsequent coverage periods.
HRA Principal #1-Flexibility According to IRS Publication 969: “HRAs are employer-established benefit plans. These may be offered in conjunction with other employer-provided health benefits. Employers have complete flexibility to offer various combinations of benefits in designing their plan. You do not have to be covered under any other health care plan to participate.”
Qualifying Business Types Schedule C Schedule F C Corporation S Corporation Limited Liability Partnership Limited Liability Company Partnership Non-Profit
Schedules C and F When it comes to an HRA self-employed business owners tend to get over-looked. Section 105(g) of the internal revenue code states: Self-employed individual not considered an employee for purposes of this section, the term “employee” does not include an individual who is an employee within the meaning of section 401(c)(1) (relating to self-employed individuals).
Self-Employed A self-employed individual cannot be an employee for the purpose of an HRA However A self-employed person can hire his/her spouse and set up an HRA.
Hiring the Spouse Upon hiring the spouse the business owner will need to fill out the necessary paper work. I-9 W-2 W-4 W-3 941/943
How it works Schedule C or Schedule F Business owner Hires Spouse Establishes HRA Elects Benefits Health Insurance Qualified Long Term Care $50,000 of Term Life (employee only) Disability (employee only) Cancer Insurance Out of Pocket Expenses Carry Over Reimburses spouse for expenses incurred by spouse and dependents