At a glance
- What it is
- A written plan under which your business reimburses your employee-spouse’s medical costs, covering the spouse, you, and your dependents.
- What it saves
- Income tax and, for sole proprietors, self-employment tax on every eligible medical dollar, not just the amount over 7.5% of income.
- Best fit
- Sole props and C corps. Not S corp 2% owners or their spouses.
- Main catch
- Your spouse has to be a real employee doing real, paid work, with records to prove it.
- Plan document
- The plan has to be in writing and in place before the expenses are reimbursed.
Key takeaways
- A Section 105 medical reimbursement plan lets your business reimburse an employee-spouse’s family medical costs and deduct them from the first dollar.
- It fits sole proprietors whose spouse genuinely works in the business, and C corps; it doesn’t work for S corp 2% owners or their spouses.
- In the illustrative example, $12,000 of family medical costs becomes fully deductible, instead of just $750 and only if itemizing.
- The catch: your spouse must be a real employee doing real, paid work, with a written plan in place before expenses are reimbursed.
The numbers
Picture a married sole proprietor with $150,000 of adjusted gross income and $12,000 a year in family medical costs: deductibles, prescriptions, dental work, and glasses. The spouse works in the business part-time for a reasonable wage. A sole proprietor’s business income is reported on the personal return, so all of these figures are personal tax.
For illustration purposes. Tax law may change, which may change these calculations slightly.
| Without plan | With plan | |
|---|---|---|
| Medical costs | $12,000 | $12,000 |
| Floor: 7.5% of $150,000 AGI | $11,250 | None |
| Amount deductible | $750, only if itemizing | $12,000 |
Personal tax saved with the plan (federal and Oklahoma)
| Federal income tax (22% bracket): $12,000 × 22% | about $2,640 |
| Federal self-employment tax: $12,000 × 92.35% × 15.3% | about $1,696 |
| Oklahoma income tax (4.5%): $12,000 × 4.5% | about $540 |
The savings are approximate. They are a little lower once you account for the QBI deduction and the deduction for half of self-employment tax, and the spouse’s wages carry their own payroll tax. Those wages should be what the work is worth; the plan is a benefit on top of pay, not a replacement for it.
Without a plan, most families get nothing for their medical bills: they take the standard deduction, and even if they itemize, only the part above 7.5% of income counts.
Could this strategy work for your business?
In a free tax analysis, your tax strategist checks whether it fits and what it could save, using your real numbers.
How it works
- Hire your spouse. A real job with real duties, a reasonable wage, and payroll with tax withheld.
- Adopt a written plan. The business adopts a Section 105 plan covering the employee, the employee’s spouse, and dependents.
- Submit and reimburse. Your spouse submits receipts for eligible medical costs, and the business reimburses them from the business account.
- The business deducts the reimbursements. They are an employee benefit expense, and they aren’t taxable income to your spouse.
Who it fits
- Sole proprietors whose spouse genuinely works in the business.
- C corps, where owner-employees can be covered directly.
- Families with meaningful out-of-pocket costs: high deductibles, dental, vision, therapy, or ongoing prescriptions.
When it doesn’t fit
- S corp 2% owners and their spouses. The attribution rules treat the spouse as a 2% owner too, so reimbursements become taxable wages.
- A spouse who doesn’t do real work in the business, or whose “job” exists only on paper.
- Businesses with other employees, unless the plan is designed to cover them too. Plans with more than one employee must meet nondiscrimination and health care law rules.
The rules
- A bona fide employee. The spouse must be a true employee, with duties, hours, and pay that match the work.
- A written plan in advance. Expenses incurred before the plan is adopted don’t qualify.
- Eligible expenses only. Medical care as defined by the tax code, with receipts. Costs reimbursed elsewhere, such as from an HSA, can’t be reimbursed twice.
- Nondiscrimination. If you have other eligible employees, the plan generally can’t favor owners and their families.
Risks to weigh
- The employment is challenged. The Tax Court has denied these deductions when the spouse’s work, hours, or pay weren’t documented. Keep time records and a job description.
- Commingled payments. Paying medical bills from a personal account and calling it a reimbursement later weakens the plan.
- Plan design. Once other employees are involved, the plan may need to be restructured, for example as a small-employer or individual-coverage arrangement with its own rules.
How we handle it for clients
With a Cannon & Brown tax plan, we check whether your entity and family situation qualify, help you put the plan and spouse’s employment in place with the right paperwork, and make sure the reimbursements are recorded correctly and deducted on your return. Because our technology keeps your numbers current all year, we can test this strategy against your real numbers and adjust it as your business changes.
Illustrative example. The family and figures on this page are hypothetical, used to explain how the strategy works. They are not a client and not a promise of results. The example assumes a sole proprietor, $150,000 of AGI, $12,000 of eligible medical costs, a 22% federal bracket, a 4.5% Oklahoma rate, and self-employment income below the Social Security wage base. This page is educational and is not tax advice for your situation; tax rules and limits change.
Brooks leads Cannon & Brown Tax Advisors, a forward-thinking tax firm serving business owners in Oklahoma and beyond. He builds year-round tax strategies that help business owners keep more of what they earn and reach their goals. More about Brooks
Common questions about Section 105 medical reimbursement plans
Can an S corp owner use a Section 105 plan for their spouse?
Generally not. The attribution rules treat the spouse of an S corp 2% owner as a 2% owner too, so the reimbursements become taxable wages instead of a tax-free benefit.
Can I reimburse medical bills I paid before setting up the plan?
No. The plan has to be in writing and in place first; expenses incurred before the plan is adopted don’t qualify.
Does my spouse have to be on payroll?
Yes. Your spouse needs a real job with real duties, a reasonable wage, and payroll with tax withheld. The Tax Court has denied these deductions when the work, hours, or pay weren’t documented.
What if my business has other employees?
Then the plan generally can’t favor owners and their families, and it must meet nondiscrimination and health care law rules. The right design depends on your setup; we check this in your free tax analysis.
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