As a self-employed individual, you are treated as a sole proprietor (i.e., you and your business are one and the same for tax purposes). Unlike the situation where your business is organized as a legal entity (e.g., a corporation or a partnership), if your business is operated as a sole proprietorship, you cannot be treated as an employee of your business. This can make a significant difference when it comes to establishing employee benefit plans.
Benefit Plans for Employees
A sole proprietorship can establish employee benefit plans for its employees that are identical to those that can be established by a corporation. Your ability to deduct the cost of such benefit plans is not affected by the fact that you are a sole proprietor, and the tax consequences to your employees are identical.
Using Employee Benefit Plans to Your Own Advantage
If you are a sole proprietor, your ability to personally take advantage of your business’s employee benefit plans is severely limited. Why? Because you’re not an employee with respect to your sole proprietorship. Therefore, most of the tax advantages associated with implementing employee benefit plans will not apply to benefits you receive individually from your sole proprietorship.
Retirement Benefit Plans
Although, generally, the tax benefits of employee benefit plans are not available to sole proprietors, this is not the case with employer-sponsored retirement plans. You are free to establish a retirement plan if you are self-employed regardless of whether or not you have employees, and you are completely free to participate in the retirement plan. However, if your proprietorship does have employees, you will probably have to include them in any retirement plan you establish for the business.
Other employee benefits you receive are generally not deductible
Generally, the cost of employee benefits, can be deducted by a business. However, if you are self-employed, you may be unable to take deductions for the cost of such benefits yourself or your deductions may be limited. This is true even if you provide similar benefits to your employees and are able to deduct the cost of these benefits.
An important exception is that if you are self-employed and you have a net profit for the year, you may be able to deduct, as an adjustment to income (i.e., “above the line”), up to 100 percent of the amount paid for medical and qualified long-term care insurance (subject to certain limitations) on behalf of yourself, your spouse, and your dependents.
Further, you may be able to deduct certain employee benefit costs incurred by your sole proprietorship that don’t qualify as business expenses on your Schedule A. For example, the cost of medical benefits that the proprietorship pays for your own benefits might be deducted as medical expenses on your Schedule A. However, if you deduct such expenses as itemized deductions on Schedule A, the medical expense deductions are only allowed to the extent that they exceed 10 percent of your adjusted gross income, and total itemized deductions may also be limited depending on adjusted gross income.
Starting in 2013, the threshold to deduct medical expenses is raised from 7.5 percent of adjusted gross income to 10 percent. The threshold increase will be delayed until 2017 for those age 65 or older.
Exceptions
Medical Coverage Exception with an Employee-Spouse
You cannot deduct as business expenses the costs associated with medical benefits for yourself. However, you can deduct as business expenses the costs associated with qualified medical benefits paid by your sole proprietorship for the benefit of your employees. See Health Insurance/Group Medical. If your spouse is also employed by your proprietorship, your spouse can be covered by the proprietorship’s qualified medical plan, and you can be covered as part of your spouse’s family. As a result, you can deduct all costs as business expenses, and the amounts paid on your spouse’s behalf would not be included in your spouse’s income.
Example: Paul is a sole proprietor of a frame shop and carries a health plan for all employees. His spouse, Robin, is an employee and therefore eligible for coverage under the medical plan. As Robin’s husband, Paul is also eligible for coverage. Paul may deduct the insurance premiums and medical reimbursements as a business expense, and Robin may exclude the same amount from her gross income.
Education Assistance Plans and Dependent Care Plans
As a sole proprietor, you may be able to take advantage of education assistance benefits and dependent care benefits.
If you have questions or need assistance, contact the experts at Henssler Financial:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
