Why does the plan usually have to cover only one employee?

The Affordable Care Act's market reform rules generally bar a stand-alone arrangement that reimburses medical expenses from covering a group of employees. A plan built around a single employee, the owner's spouse, sits within those rules, which is why the single-employee design is the whole architecture rather than a detail. Adding a second covered employee without a compliant design breaks the plan, and that is the most common do-it-yourself failure.

Does this work the same way for an S-corporation owner?

No. An owner who is a more-than-two-percent shareholder of an S-corporation is not treated as a rank-and-file employee for these health benefits, so employing a spouse does not automatically hand the owner the same medical reimbursement treatment. Those shareholder rules interact with the plan design and with how the benefit is reported on the owner's Form W-2. Work the interaction through with a CPA before the business relies on the arrangement.

Does my spouse really have to work for the business?

Yes. Both the wages and the reimbursement plan rest on the spouse being a bona fide employee with real duties, a reasonable wage, and payment from the business account like any other worker. A spouse on the books in name only leaves no employment relationship to support either the pay or the benefits, which makes the wage deduction and every reimbursement under the plan indefensible.

Employing a spouse and a medical reimbursement plan

Employing a spouse who does real work for your business can open a written medical reimbursement plan that reimburses the family's medical costs as a business expense, and it adds a second retirement-plan participant. The design depends on the spouse being a genuine employee and, in most cases, on the plan covering only that one employee.

Verify annually — figures adjust

Limits and thresholds tied to these health and reimbursement rules adjust from year to year. Confirm the current figures and plan requirements against irs.gov before relying on them.

No capital outlay

There is no capital outlay. The costs are the spouse's reasonable wages for real work and the expense of setting up and maintaining a proper written plan, plus payroll administration. The reimbursements themselves are money you were already spending on family medical care, now routed through a deductible plan.

Key points

A spouse who is a bona fide employee can be covered by a written plan reimbursing the employee's family medical expenses as a business expense.
Because the employee-spouse's family includes the owner and the children, a properly designed plan makes out-of-pocket family medical costs deductible and the reimbursement untaxed.
Employing a spouse also creates a second participant in the business retirement plan, which can expand total household retirement contributions.
The Affordable Care Act market reform rules generally prevent a stand-alone medical reimbursement arrangement from covering more than one employee.
A more-than-two-percent S-corporation shareholder is not treated as a rank-and-file employee for these health benefits, so the owner's treatment differs.

What is it?

When your spouse is a bona fide employee of your business, the business can adopt a written plan that reimburses the employee for medical expenses, including expenses of the employee's family. Because the spouse's family includes you and your children, a properly designed plan can turn out-of-pocket family medical costs into a deductible business expense while the reimbursement is not taxable to the employee.

Employing the spouse also creates a second participant in the business's retirement plan, which can expand the household's total retirement contributions. These benefits stack, but they all rest on the same foundation: the spouse must actually work for the business and be paid for it like any other employee.

A crucial constraint governs how the medical plan is designed. The Affordable Care Act's market reform rules generally prevent a stand-alone arrangement that reimburses medical expenses from covering more than one employee. The single-employee design is the entire point, and it is precisely where do-it-yourself versions fail, because owners add a second employee and unknowingly break the plan.

The rules also treat owners of an S-corporation differently. A more-than-two-percent shareholder is not in the same position as a rank-and-file employee for these fringe benefits, so an owner cannot simply assume the spouse arrangement gives the owner the same treatment. That interaction has to be worked through before relying on the plan.

Statutory basis

Who does it apply to?

Owners whose spouse genuinely works in the business and can be paid a reasonable wage for that work.

Smaller businesses where the spouse can be the only employee covered by a medical reimbursement arrangement, which is the design the rules favor.

Households looking to convert family medical costs into a deductible business expense and to expand retirement participation, where the underlying employment is real.

Who does it not work for?

Arrangements where the spouse does not actually work for the business, which makes both the wages and the reimbursement plan indefensible.
Businesses with more than one employee that try to run a stand-alone medical reimbursement plan without a design that satisfies the market reform rules.
Situations with no written plan document, since the reimbursement of medical expenses depends on a formal plan being in place.
S-corporation owners who assume the more-than-two-percent shareholder rules let them take the same medical reimbursement treatment as a regular employee.

What does the IRS look at?

Whether the spouse is a genuine employee — real duties, a reasonable wage, and payment from the business account like any other worker.
Whether a written plan document exists and the reimbursements follow its terms rather than being ad hoc payments.
Whether the plan covers only the number of employees its design can lawfully cover under the market reform rules.
Whether the reimbursed expenses are genuine medical expenses and are substantiated.
Whether the treatment claimed accounts correctly for the S-corporation more-than-two-percent shareholder rules where the owner is involved.

What does it cost to fund, and when does the window close?

A CPA or benefits professional should draft the plan document, confirm the single-employee design fits your situation, and coordinate the S-corporation shareholder rules. Because the plan must be in place before expenses are reimbursed under it, set it up at the start of the year rather than at filing time.

Related strategies

Common questions

Why does the plan usually have to cover only one employee?: The Affordable Care Act's market reform rules generally bar a stand-alone arrangement that reimburses medical expenses from covering a group of employees. A plan built around a single employee, the owner's spouse, sits within those rules, which is why the single-employee design is the whole architecture rather than a detail. Adding a second covered employee without a compliant design breaks the plan, and that is the most common do-it-yourself failure.
Does this work the same way for an S-corporation owner?: No. An owner who is a more-than-two-percent shareholder of an S-corporation is not treated as a rank-and-file employee for these health benefits, so employing a spouse does not automatically hand the owner the same medical reimbursement treatment. Those shareholder rules interact with the plan design and with how the benefit is reported on the owner's Form W-2. Work the interaction through with a CPA before the business relies on the arrangement.
Does my spouse really have to work for the business?: Yes. Both the wages and the reimbursement plan rest on the spouse being a bona fide employee with real duties, a reasonable wage, and payment from the business account like any other worker. A spouse on the books in name only leaves no employment relationship to support either the pay or the benefits, which makes the wage deduction and every reimbursement under the plan indefensible.

Mena Hemaia, CPA, CIA

Chief Executive Officer, Accountack — West Palm Beach, Florida

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