If you are a self employed tax payer, only portions of your health insurance premiums are tax deductible in 1999.
However, there are many ways you can deduct ALL your health insurance costs.
Using the usual forum of an Industry Specialization Program (ISP) paper, the IRS has approved a controversial "back door approach".
Background: As a general rule, an employer can deduct all the health insurance premiums it pays on behalf of employees, including coverage for the employees family. The employer-paid coverage is also tax-free to the employee. In contrast, self-employed business people can only claim a percentage of their health insurance premiums as an above-the-line deduction.
The allowable percentage for 1999 is 60%. (Eventually, this figure will increase until it reaches 100% in 2003 and thereafter).
Common Situation: Your spouse often helps out in your self-employed business. By hiring your spouse as an official employee, you can provide him/her with deductible health insurance coverage. And you are covered through the "backdoor" as the spouse of an employee.
Tax Consequences: In a prior Revenue Ruling, the IRS said that medical plan reimbursement paid by a self-employed taxpayer to his spouse who was one of his employees were fully deductible and tax free to the spouse. (Rev. Rul. 71-588, 1971-2 CB 91)
Results: By covering the medical expense of each employees family, the self employed owner effectively deducted his own insurance costs.
A subsequent private letter ruling implied that a self-employed could use this ruling even if the spouse was the sole employee of the business. (PLR 199409001).
Previously, this strategy was considered to be risky by some tax experts. Now the IRS has provided definitive guidelines in the new ISP paper.
The paper says that the cost of health insurance, including medical reimbursements, is fully deductible as long as the spouse is a bona fide employee. Part-time status is acceptable unless services are minimal or insignificant. Similarly, the cost of the coverage or reimbursement is tax free as long as the spouse actually performs applicable services for your business.
To benefit from this new tax break, your health insurance plan must specify that an employee spouse is eligible to participate in this plan.
Suggestion: Establish a waiting period or service requirement to obtain coverage under that plan, especially if other employees have previously been excluded from coverage for that reason.
NOTE: The IRS says the back door approach can’t be used by more than 2% owners of S Corporations. That’s because an employee-spouse of the owner is treated as an owner for certain fringe benefit purposes, including health insurance plans.
REA Reporter, Certified Public Accountants, August 1999, Post Rd, Columbus, OH 43017-1117 and seven other Ohio locations. Accounting assistance can be obtained by calling (614) 889-8725.
