Sole proprietor hires spouse. Can she participate?

[katieinny]

I know that a sole proprietor can't set up a medical expense reimbursement plan for himself, but what if he hires his spouse? Can he set up the plan for her to participate in?

[Everett Moreland]

ftp://ftp.irs.gov/pub/irs-isp/all-cafh.pdf

[katieinny]

Excellent! Thank you for pointing me in the right direction.

[katieinny]

Everett: I just read through the information -- but it seems to deal with the spouse having health insurance and medical reimbursements under 105(b) -- but I'm wondering about medical expense reimbursements through a cafeteria plan under 105(h). Have you got another weblink up your sleeve?

[GBurns]

Why would medical expense reimbursements through a cafeteria plan (or even otherwise) be under 105(h)?

[Everett Moreland]

katieinny:

I don't have another weblink up my sleeve. I provided the link because I assumed your cafeteria plan issue turns on the 105 issue, but I only know enough about cafeteria plans to be dangerous.

[jmor99]

I'm guessing not likely if his wife is going to be the only employee, and maybe not otherwise. Look at section 125(e)(1)(D) which defines a highly compensated participant: "a spouse or dependent (within the meaning of section 152) of an individual described in subparagraph (A), (B), or ©." If you look at A,B,and C, they are: an officer, a shareholder owning more than 5%........, highly compensated. Therefore, she would be a highly compensated participant. In which case if you then go back to 125(b)(B), it basically states that the plan cannot discriminate in favor of HCEs as to contributions and benefits. Which is exactly what would be happening if she is the only other other employee.

IF there are other employees, who are participants, then MAYBE they can pass all the discrimination tests.

[katieinny]

I'm so confused about HRAs, HSAs, HDHPs and FSAs (just to name a few) that I don't know which end is up anymore.

In this case, the sole proprietor, with no other employees, is thinking of hiring his wife. He's wondering if he can set up a Health Reimbursement Arrangement under 105(h). She would be the only participant, he would be her dependent. I shouldn't have brought up cafeteria plans, but to me, they're all part of the same soup.

It seems likely that the HCEs regs that apply under 125 plans (as mentioned by jmor99) would apply here as well, but I've learned that what seems likely isn't always the case.

[GBurns]

HRAs are not set up under 105(h).

What benefit do you see that they would get using employee salary reductions, which would be the main source of funds for an FSA, or employer contributions to an HRA?

This is a sole proprietorship, why is anything other than a standard 105 MERP needed? Are there other employees who would have to be given the benefit also?

[Guest mjb]

K: If the sole prop incorporates he can exclude all med expenses for himself and his dependents under a med reimbursement plan under 105/106. See e.g., RW Tschetter 86 TCM 639 (2003). Why bother with a 125 plan?

[GBurns]

If he remains a sole prop, she has to be a bona fide employee. If he incorporates as an S Corp or LLC etc ther would still be issues. There have been a number of cases where the IRS prevailed because the employee relationship etc was not valid. Here is something that you should look at for starters:

IRS_FSA_19991111_re_105_Plans_for_SE.doc

[Guest mjb]

If he incorporates the employer can deduct his and his spouse's med expenses as a dependent without having to employ her. I dont know what other issues your are thinking about. The case that I cited was one of 4 similar cases decided by the tax court on this issue, all of which found for the taxpayer on the medical expense deductions under 105/106.

The IRS FSA you cite is totally off point because it had to do with self employed persons hiring their spouse in order to purchase a tax deductible insurance policy for the spouse and the spouse's dependents as an employee of the self employed person since in 1993 self employed persons could not deduct health insurance premiums for themselves. The addition of IRC 162(l) permits self employed persons to deduct 100% of their health ins premiums from their income without having to employ the spouse which is why the memo is obsolete.

[katieinny]

At this point, the sole proprietor isn't interested in incorporating. So, it sounds like hiring his spouse and putting in a Health Reimbursement Plan isn't going to work as things stand right now. Thanks for your help.