Kelly Kearsly for the Wall St. Journal writes: The doctor and his wife routinely spent more than $20,000 a year on medical expenses for a young son with a chronic illness. But the doctor's high salary meant he couldn't deduct any of that expense from his income taxes. So Troy Von Haefen, a fee-only financial planner in Nashville, Tenn., came up with another strategy that effectively turned the medical costs into a business expense.
The doctor typically earned more than $500,000 per year, and tax rules would only allow for a deduction of health care costs exceeding 7.5% of income. "It just wasn't plausible," says Mr. Von Haefen, who provides financial planning--though he doesn't manage investments--for three dozen clients who are mostly musicians and small business owners.
The strategy he suggested is one he uses himself. It involves using a Section 105 Health Reimbursement Account. These plans are employer-funded, tax advantaged accounts or arrangements that reimburse employees for out-of-pocket health care expenses. The referenced tax code allows for self-employed individuals to hire their spouses and provide them with a medical benefits package that encompasses the couple and their children.
"It ends up being a family plan, so that the husband, wife and all the kids can jump on board," Mr. Von Haefen says.
Mr. Von Haefen suggested the doctor hire his wife to do administrative work, such as scheduling and bookkeeping. He cautioned the spouse must be qualified for the job, be paid a fair--and not excessive--wage and actually do the work. "I want to keep it all above board," he says.
So the doctor hired his wife for 10 hours of work each week at a rate of $25 per hour. The HRA the doctor set up, with help of a plan administrator, allows him to reimburse up to 80% of his wife's wages for health-care costs. The exact percentage that is reimbursable is determined by the doctor and the company administering the plan at the beginning of each year and can vary based on the spouse's income and the family's expected medical expenses.
Under this arrangement, the doctor pays his wife 20% of her earnings and retains the remaining 80%. Then, throughout the year, or at the end of the year, the wife submits the family's medical expenses to her husband and he reimburses her. If the annual medical expenses are less than the amount the wife has earned, the extra rolls over into the next year.
For example, if the wife earns $1,000 per month, she receives only $200 in her paycheck. The doctor keeps the other $800 and uses it to reimburse his spouse when she submits the family's expenses. The savings come in spades: Because the health plan is now a business expense, the family can deduct those medical cost reimbursement--and avoid federal, state and Medicare taxes on those dollars.
Mr. Von Haefen says because the wife is now formally employed, the couple also becomes eligible for the child-care deduction. Altogether, the arrangement provides this family about $4,000 to $5,000 a year in tax savings.
The plan does have some costs. Mr. Von Haefen recommends that clients hire both a plan administrator to set up and manage the arrangement, and a payroll service company. The first can cost as little as $200 per year, and the latter about $450 annually. "There are some associated costs, but they don't compare to the tax benefits," he says.
The doctor and his wife have been using their HRA for two years and they're pleased with their savings--and their new working arrangement.
"It doesn't always work, because some spouses don't want to work together," Mr. Von Haefen says. "But in the right situation it can be a home run."
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