I love the Medical Reimbursement plans. These work only for Sole Proprietorships (or LLCs taxed as Sole Proprietorships) and C Corporations.
They differ from a “Cafeteria Plan” that allows you to put money aside before taxes from your pay check. The Medical Reimbursement plan allows you to reimburse for medical expenses as you incur them.
A recent court case denied the deduction for a Sole Proprietorship. What did he do wrong? And, even more importantly, how can you make sure you don’t make the same mistake?
In this case, the taxpayer employed his wife and had an employment agreement. The problem was the employment agreement didn’t look like a real agreement. For example, it didn’t say how many hours she would work, she didn’t have to keep a time log or submit anything to get “paid” (which was just credited from the amount that was paid from the business to them jointly), or even how much she was paid her hour. It was impossible to say if the wage paid to her was reasonable because there was nothing there about how many hours or how frequently she had to work.
The burden of proof is always higher when you use a tax loophole for a related party. In this case, the taxpayer lost a $9,000+ tax deduction. Take the extra time to make sure your documentation matches what you say it will. It could save you thousands!