Can you deduct medical expenses on your taxes as part of your law firm's business expenses? You might be surprised at how easily it can be done by using a health reimbursement account, also known as an HRA, or a medical reimbursement account. The account must be part of an employee benefit plan.
Medical Deductions and IRS Code Section 105
Under Internal Revenue Code Section 105, a business can provide employees with health reimbursement accounts as a benefit of employment. The employee's medical expenses are paid or reimbursed by the business up to a certain dollar amount as part of the employee's compensation. This payment of medical expenses does not constitute income to the employee for tax purposes, but it does qualify as a legitimate business expense and gives a significant tax deduction to the law firm or other business that provides the employee benefit.
Expenses that qualify for a deduction under an HRA are usually the same as those that qualify under a Flexible Spending Account or FSA.
Requirements for Deducting Medical Expenses
Deducting medical expenses depends on two important requirements:
- The funding of the HRA must be provided solely by the employer. No portion of the cost can be deducted from the employee's compensation.
- Benefits can be provided only for substantiated medical expenses. If an expense is not listed on the standard pre-approved types of expenditures, such as medical bills or pharmacy expenses for prescribed medications, written orders from a physician designating the medical necessity of the item may be required.
Medical Deductions and Business Structure
HRAs are subject to various limitations depending on your business structure.
- Sole proprietorships: Attorneys in solo practice cannot set up an HRA directly for themselves, but they can employ spouses on a minimal part-time basis and provide most of the spouse's compensation in the form of an HRA with family coverage. The owner/attorney becomes the dependent of his employee/spouse, and his medical expenses are covered through a backdoor approach. A sole practitioner must be able to show that his spouse is legitimately performing work for the business.
- Partnerships: Attorneys working in partnerships must follow the same rules as sole proprietorships to have their own medical bills covered under an HRA. If partners are married, however, such as in a husband-and-wife law firm, they cannot obtain coverage this way.
- C-Corporations: Law firms operating as C-corporations can provide the deduction for their employees, including the attorney/owners, without going through the extra step of employing their spouses.
- S-Corporations: These corporations are a bit trickier, and special rules apply to benefits paid to an employee who owns more than 2 percent of the firm. Non-shareholder employees can participate in the plan without any difficulty, however.
- Limited Liability Companies: The rules for LLCs depend on which taxation method the company has chosen. Some LLCs are treated as sole proprietorships, some as partnerships, and still others operate as corporations. Check with your accountant if you're unclear on which tax classification your firm has elected.
Start Deducting Medical Expenses
Starting an HRA involves a lot of paperwork and recordkeeping if you do it on your own. Many firms hire third-party administrators, such as TASC, to set up their programs at a minimal cost. TASC is not the only company out there providing this service, but it's the one we chose for our firm, and it has worked out very well.