Can medical bills be deducted on your taxes as business expenses at your law firm? You may be surprised at how easily it can be done using a Health Reimbursement Account (HRA) (also known as a medical reimbursement account) as part of an employee benefit plan. This is one aspect of law firm financial management where a solo practitioner may have an advantage over the big-firm lawyers because of the way the account works, especially for a solo practice with no employees.IRS Code Section 105
Under Internal Revenue Service (IRS) Code Section 105, a business can provide employees with a Health Reimbursement Account (HRA), as one of their benefits of employment. Under the HRA plan, the employee's medical expenses (up to a certain designated dollar amount) are paid or reimbursed by the business 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 giving a significant tax deduction to the law firm or other business providing the employee benefit. The kinds of items that qualify for a deduction under an HRA are basically the same as those that qualify under a Flexible Spending Account (FSA).Requirements
Two of the most important requirements for an HRA to be legitimate are that (1) the funding of the HRA must be provided solely by the employer (meaning it cannot be deducted from the employee's compensation, but is in addition to it) and (2) benefits can only be provided for substantiated medical expenses. If an item is not on the standard pre-approved types of expenditures such as medical bills or pharmacy expenses for prescribed medications, then written orders from a physician designating the medical necessity of the item may be required.
Additionally, HRAs are subject to various limitations depending on the type of business structure involved. For example:
- Sole proprietorships. Attorneys in solo practice cannot set up a HRA directly for themselves. However, they can employ their spouse on a minimal part-time basis and provide most of the spouse's compensation in the form of an HRA with family coverage. Under this approach, the owner becomes the dependent of his or her employee-spouse and gets his or her own medical expenses covered through a back-door approach. A sole practitioner must be able to show how the spouse is legitimately performing work for the business, but most spouses of solo practice firms are involved in the business in some way anyway.
- Partnerships. Attorneys working in a partnership have to follow the same rules as a sole proprietorship in order to get their own medical bills covered under an HRA. However, if the partners are married (such as a husband-and-wife law firm), then they aren't going to be able to obtain coverage this way.
- C-Corporations. Law firms operating as C-corporations can provide the deduction for the employees (including the attorney-owners) without going through the extra step of making their spouses into employees.
- S-Corporations. S-corporations are a bit more tricky,and special rules are going to apply to any benefits paid to an employee who also owns more than 2% of the firm. However, non-shareholder employees can participate in the plan without any difficulty.
- Limited Liability Company.The rules for a limited liability company (LLC) will be determined by which taxation method has been chosen by the LLC. Some LLCs are treated as sole proprietorships, some as partnerships, and some as corporations. If you are unclear on which tax classification you are using, check with your accountant.
Starting a HRA involves a lot of paperwork and a lot of record-keeping if you do it on your own. To simplify the process, most businesses hire a company such as TASC to set up their program at a minimal cost. If you are interested in setting up a HRA at your law firm or if you just have questions about whether you qualify, contact Kelly Erdman, Lead Microbusiness Specialist at TASC, at (800) 422-4661 Ext. 2450. TASC is not the only company that can provide this program, but they were the one we chose to set up the program at our firm and it has worked very well.