Barbara’s Blog

Health Savings Accounts (HSAs) may be an alternative way to obtain health coverage for you and your staff without experiencing the double-digit premium increases for traditional health coverage. As of January 1, 2010, there were about 10 million people covered by HSAs, which was an increase of 25% from the previous year; 2011 statistics are expected next month.

With no end in sight on the premiums hikes for traditional coverage, more small business owners and self-employed individuals are using or considering the use of HSAs–and for good reason.

Advantages of HSAs
Health savings accounts, combined with high-deductible health plans (HDHPs), can save businesses as much as 40% compared with traditional coverage (savings depend on whether the employer or employee pays the HDHP premiums and/or makes the HSA contributions). HDHPs are low-cost insurance plans designed primarily for catastrophic coverage; the shortfall in costs is supposed to be supplemented by HSAs.

HSAs are IRA-like accounts that produce a triple tax benefit:

• Contributions are tax deductible.

• Earnings on contributions are tax deferred.

• Withdrawals to pay eligible medical costs (e.g., doctors’ bills, prescription drugs, and doctor-prescribed over-the-counter medications) are tax free.

There’s yet another tax-savings incentive. There is no FICA tax paid on HSA contributions made by employees when made on a pre-tax basis. In order to do this, the employer needs to set up a salary reduction plan (“cafeteria plan”) to make pre-tax contributions possible.

Use an online calculator to figure your savings from an HDHP/HSA arrangement versus traditional coverage.

Tax rules for 2011
To be eligible to make contributions to HSAs in 2011, there must be an HDHP in effect that has minimum deductibles and maximum out-of-pocket limitations for costs such as policy deductibles, co-payments, and other amounts.

• Self-only (individual coverage) plans: minimum deductible of $1,200 and out-of-pocket limit of $5,950.

• Family plans: minimum deductible of $2,400 and out-of-pocket limit of $11,900

The maximum HSA contribution for 2011 is:

• $3,050 for self-only coverage

• $6,150 for family coverage

Anyone age 55 or older by the end of the year can add another $1,000.

Tax rules for 2012
It’s not too early to start planning for your health coverage in 2012. This gives you time to shop around and assess your options. To help you comparison shop, the IRS has announced the HSA limits for next year.

The HDHP parameters for 2012:

• Self-only (individual coverage) plans: minimum deductible of $1,200 and out-of-pocket limit of $6,050.

• Family plans: minimum deductible of $2,400 and out-of-pocket limit of $12,100.

The maximum HSA contribution for 2012 is:

• $3,100 for self-only coverage

• $6,250 for family coverage

Again, anyone age 55 or older by the end of the year can add another $1,000.

For more about Health Savings Accounts, see chapter 19 in my book, J.K. Lasser’s Small Business Taxes 2011, and IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.

When businesses start up, one in three operates as sole proprietorship; most of the others form limited liability companies or S corporations. Practically no businesses start out as C corporations, but maybe they should. Business owners may be overlooking opportunities in being a regular, C corporation.

Raising capital
There is a special tax rule that benefits investors of certain C corporations. It allows them to pay no tax on gain from the sale of “qualified small business stock” (QSBS) if they hold the stock for more than five years. So, being a C corporation may help to raise capital.

To qualify for the 100% exclusion, all of the following rules must be met:

• The stock must be acquired after September 27, 2010, and before January 1, 2011.

• The corporation must be an operating business (not a holding company or hedge fund).

• The corporation cannot be involved in certain service businesses and professional activities (such as law or medicine), financial services, banking, farming, the extraction of natural resources, and the operation of hotels, motels, restaurants or other similar businesses.

• The gross assets of the corporation cannot exceed $50 million.

• The stock must be acquired by noncorporate taxpayers — individuals and pass-through entities such as partnerships, S corporations, and trusts –  directly from the corporation or from an underwriter.

Thus, a C corporation may be a good idea for tech companies, manufacturers, and retailers that can meet “qualified small business” criteria. QSBS can be used to raise financing for the business. It can also be used for compensation to valued employees (QSBS can be acquired in exchange for services).

Medical reimbursement plans
Businesses of any type can use a variety of arrangements for medical assistance to employees, including flexible spending accounts (FSAs), health savings accounts (HSAs), and health reimbursement arrangements (HRAs). However, only C corporations can offer employees a medical reimbursement plan (a “Section 105 plan”). This arrangement will cover a set dollar amount of health expenses of employees. The plan must be nondiscriminatory, but can cover owner-employees without restriction.

For example, say a one-person company is a C corporation with a medical reimbursement plan. The plan offers reimbursements up to $5,000 of uninsured medical costs for the owner-employee, as well as his/her spouse and dependent(s). As long as the language of the plan provides comparable coverage for all employees, the owner-employee is not taxed on the reimbursements while the corporation deducts them.

Lower taxes
Congress currently is debating a reduction in the corporate tax rate. The U.S. now has the highest corporate rate among developed countries throughout the world. Japan’s rate, which had been 39.5%, dropped its rate on April 1 by 4.5%, bringing it well below the U.S.’s rate of 39.2% (combined federal and state rates). The U.K. also dropped its rate on April 1 from 28% to 27% in a multi-year rate decrease that will reach 24% in 2014. The average rate for countries in the Organization of Economic Cooperation and Development (other than the U.S.) is 25.5%. The Tax Foundation has a chart of rates.

In the State of the Union address, President Obama called for a reduction in the 35% corporate rate, which has been the rate since 1993.

Various proposals in Congress have suggested a reduction in the top rate to as low as 24% or so. The House Ways and Means Committee is holding hearings today on corporate tax reform in the context of a global market.

There has been no corresponding suggestion for a reduction in the top individual tax rate, which is 35% through 2012. If President Obama has his way, this rate will rise to 39.6% in 2013. Thus, owners of C corporations would be in a position to shelter corporate earnings and eventually withdraw them at favorable capital gains rates by selling shares; owners of other entities would likely be at a tax disadvantage.

Bottom line
Business owners should review their entity options with a knowledgeable tax practitioner, considering not only the factors I’ve discussed, but state tax issues, also.

The goal of the new law, which passed the Senate on September 16 and is expected to pass the House and then be signed into law any day now, is to help small businesses create 500,000 jobs.  According to the NFIB and to common sense, this likely won’t happen. But the new law does have $12 billion in tax breaks that could benefit certain businesses. Here’s a quick rundown of how you may be able to lower your tax bill: 

• Self-employed tax savings. Until now self-employed individuals could not reduce their self-employment tax by the amount of medical insurance premiums they paid to cover themselves, their spouses and dependents (although premiums for staff are a deductible business expense). Under the new law, for 2010 only, they can. For instance, if you are self-employed and pay $10,000 in premiums this year, you’ll save about $1,500 in self-employment tax.

• Increased write-offs for certain business investments. Under the so-called Section 179 deduction rule, if you buy new or pre-owned equipment and machinery, you can deduct up to $500,000 in 2010 and 2011 rather than depreciate the cost over a number of years. The dollar limit phases out when total equipment purchases for the year exceed $2 million. Eligible equipment includes off-the-shelf software and, for the first time, qualified leasehold, restaurant, and retail improvements up to $250,000 in 2010 and 2011. In addition, you can claim bonus depreciation on new equipment purchases, which amounts to an additional 50% deduction in excess of any Section 179 deduction claimed.

• Increased exclusion for qualified small business stock gains. If you invest in a small C corporation after the date of enactment and before January 1, 2011, you won’t pay any capital gains when you sell the stock as long as you’ve held it for at least five years.

• Increased write-off for start-up costs. Instead of being able to deduct up to $5,000 of start-up costs in the first year of business, you can deduct up to $10,000 for costs this year. The dollar limit phases out when total start-up costs exceed $60,000, but very few small business start-ups have initial costs that approach this figure.

To help pay for these tax breaks, businesses of all sizes (no small business exemption) that are recipients of rental income will have to report payments to service providers (e.g., painters, plumbers, accountants) of $600 or more in a year, starting in 2011.

Will any of these new tax breaks help you? Do any inspire you to create jobs? Please let me know.