Medical Expense Reimbursement

By John Ellsworth, Esq March 23rd, 2009

Save Big Money With A Medical Expense Reimbursement Plan

Business owners who operate under an entity structure that includes a C corporation have reason to celebrate. The IRS has announced a new policy that makes one of the best tax shelters in the Internal Revenue Code’s “a corporate medical reimbursement plan” even sweeter. Here’s what happened: In Revenue Ruling 2003-102, released September 5, 2003, the IRS announced that various employer sponsored medical plans, including a corporate medical reimbursement plan, can reimburse employees for “over-the-counter” medicines, drugs and dietary supplements that are purchased without prescriptions. Such reimbursements are not included in the employee’s gross income! This is a change from prior practice, and it could be a big deal depending on your individual situation. Up to this point, medical reimbursement plans routinely provided that employees could be reimbursed for purchases of medicines and drugs only if they were purchased on a prescription issued by a physician.

Now the requirement that such medical expenses be reimbursable only if purchased by prescription is tossed out. That means that your purchases of antacids, an allergy medicine, a pain reliever, and a cold medicine from a pharmacy – all without a prescription – are now eligible for reimbursement under a medical reimbursement plan.

INDIVIDUAL DEDUCTIONS vs. CORPORATE MEDICAL REIMBURSEMENT PLANS

Let’s go back and look at some of the background rules. Generally, if a taxpayer has expenses for medical care, those expenses can be deducted from adjusted gross income, but only with two severe restrictions: (a) the taxpayer has to itemize deductions, and (b) the deduction is allowed only for expenses that exceed 7.5% of adjusted gross income. Those restrictions pretty much wipe out the deduction for most taxpayers. Very few people can get above the 7.5% floor.

But Congress inserted a great tax break into the Code by providing that a corporate employer can pass a medical reimbursement plan.

What is a Corporate Medical Reimbursement Plan?

And why is it one of the most powerful tax breaks for corporate owners and employees?

  1. It pays for 100% of your medical insurance premiums.
  2. Allows you to deduct 100% of your health plan deductibles, out-of-pocket expenses and co-pays.
  3. You can even deduct the costs of pre-existing conditions!
  4. Deduct the costs of braces and other dental work.
  5. Deduct the costs of driving to and from the doctor.
  6. Deduct the costs of hearing aids and glasses.
  7. Deduct the costs of nontraditional forms of medicine such as chiropractic, acupuncture, and massage therapy.
  8. It covers you, your spouse and your children!

For many people these expenses can add up to thousands of dollars every year. If you have a business, and have not set-up a legal entity, this is one more reason to look at incorporating your business.

Under such a plan the corporation can reimburse the employee for expenses incurred by the employee for the medical care of the taxpayer or the taxpayer’s spouse or dependents. This means the medical expenses get paid for with corporate pretax dollars. The problem with the 7.5% floor for individual deductions is avoided; the medical expenses are covered by the medical reimbursement plan and the taxpayer doesn’t bother with the individual deduction that he probably couldn’t have used anyway.

The further good news: The corporate medical reimbursements under the plan are NOT included in income of the employee who is reimbursed! Sweet deal!

Up to the point where Rev. Ruling 2003-102 was issued, it was understood that in order for a medical expense to be reimbursable under a medical reimbursement plan, that expense had to be deductible for itemization purposes. Medicines, drugs and dietary supplements are deductible only if obtained by prescription, so tax practitioners believed (and advised their clients) that such medicines, drugs and dietary supplements were eligible for reimbursement under a medical reimbursement plan only if obtained by prescription also. The rules for medical reimbursement plans and individual medical deductions were the same – so everyone believed.

Now Rev. Rul. 2003-104 has burst on the scene. In what can only be described as a very friendly, pro-taxpayer announcement, the IRS is giving taxpayers a real break. Medical expenses are soaring and have become a heavy burden on Middle America. Taxpayers need a break on medical expenses, and Rev. Rul. 2003-104 is exactly the type of “medicine” that is needed.

MEDICAL REIMBURSEMENT PLANS REQUIRE A CORPORATION, NOT A LLC

One of the requirements in the Internal Revenue Code for a medical reimbursement plan is that the plan is intended to benefit employees. The Code defines employees in different ways for different purposes throughout the Code. But for medical reimbursement plan purposes, a partner in a partnership (or a member in a LLC) is not deemed to be an “employee”. So the rub is that a LLC cannot provide the same medical reimbursement plan to its owners in the same fashion that a corporation can. This is an area where a corporation can provide benefits to its owners that no other business entity can provide.

Do not over-read the point in the above paragraph. It is possible for a LLC to pay medical insurance premiums for its owners with entity pretax dollars, but that is accomplished under a different Code section (dealing with “self-employed medical insurance deductions”) than the one that governs medical reimbursement plans. So the LLC can pay for the owners’ medical insurance premiums, but that’s it. The LLC cannot pay the owners’ uninsured medical expenses, deductibles, copays, and other uninsured medical expenses without such payments being taxable income to the owners.

WHICH EXPENSES ARE REIMBURSABLE UNDER A CORPORATE MEDICAL REIMBURSEMENT PLAN?

The Revenue Ruling makes an important distinction on which medical expenses are reimbursable. While medicine and drugs are reimbursable, regardless of whether they are purchased on prescription, items that are”merely beneficial to [an employee] or [an employee's] spouse or dependents’ general good health” are not reimbursable. The Revenue Ruling specifically mentions vitamins purchased to maintain general health as being non-reimbursable. Toiletries such as toothpaste, cosmetics and face creams, and sundry items are also listed as not reimbursable.

So here’s the important distinction: If an item is purchased for the diagnosis, cure, mitigation, treatment, prevention of disease, or affecting the structure or function of the body, then it is reimbursable. In contrast, if an item is “merely beneficial to general good health” it is not reimbursable.

In most instances, that distinction will be a fairly bright line. But there are going to be some gray areas, some fuzzy situations. What about antioxidant vitamins for persons with risk factors for heart disease? Some medical studies indicate that such antioxidants can significantly reduce heart disease; other studies report that the use of such antioxidants is inconclusive. The “œexperts” do not agree.

Probably the most that can be said about these “gray areas” is that you should discuss your specific circumstances with your tax adviser to get an opinion on the propriety of reimbursement, and assess your own comfort level in proceeding in the face of uncertainty.

DOES YOUR CORPORATION’S MEDICAL REIMBURSEMENT PLAN NEED TO BE AMENDED TO TAKE ADVANTAGE OF THIS NEW DEVELOPMENT?

There is a final point, and it is important. Notwithstanding the good news of Rev. Rul. 2003-102, no medical expenses are reimbursable unless the medical reimbursement plan so provides. Be sure to confirm this with your tax attorney. Most, if not all, medical reimbursement plans were originally drafted to provide reimbursement for items that were “deductible” i.e., only medicine and drugs purchased with prescriptions. Indeed, most well-drafted medical reimbursement plans contained language that was taken verbatim from the regulations, such as the following:

“Reimbursement shall not be made for cosmetic surgery, or drugs, optical equipment or other appliances, unless purchased upon prescription of a physician, dentist or other treating person.”

This type of language is fatal to the reimbursement opportunity provided by Rev. Rul. 2003-102. If the language of the medical reimbursement plan restricts the reimbursement of medicines and drugs to those purchased with prescriptions, then the medical reimbursement plan needs to be amended immediately. Unless the language of the medical reimbursement plan allows the reimbursement of over-the-counter drugs and medicines, Rev. Rul. 2003-102 does no good.

Hence it is incumbent upon every corporate officer and director of a corporation with a medical reimbursement plan to have the medical reimbursement plan reviewed and amended to expand the scope of expenses that are reimbursable to the fullest extent allowed by the new Revenue Ruling. If you don’t, you might get a headache. And if you do, the aspirin you take won’t be reimbursable. That would be a real migraine!

P.S. For those of you who would like assistance updating or establishing a Medical Reimbursement Plan, I have put together the Medical Reimbursement Plan Doc File. It has everything you need to implement a new plan, or make the correct changes to your current one. It includes:

  1. Waiver of Notice of Special Meeting of the Board of Directors
  2. Minutes of Special Meeting of the Board of Directors
  3. Amended Medical, Dental and Vision Reimbursement Plan
  4. Employee Letter
  5. Complete Step-By-Step Instructions

This entry was posted on Monday, March 23rd, 2009 at 2:57 pm and is filed under tax filing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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