Medical Insurance And The Choice of Business Entity

After an individual has decided to start her/his own business with a particular product or service in mind, critical decisions have to be made as to the type of entity to be utilized in the business. An individual will have to decide whether this new venture will be a sole proprietorship, a partnership, a limited liability company, an "S" corporation, or a "C" corporation. In previous Newsletters we have outlined some of the advantages and disadvantages of each type of entity. This discussion will examine the tax treatment of two particular areas of business expenses: medical insurance and automobile use under the different types of business organizations.

One of the most important considerations for any individual in the work force is the availability of medical insurance through her/his employer. Presently, a self-employed individual may only deduct 25% of the health insurance premium as a business expense on the Federal Income Tax Return. In other words, 75% of the cost of health insurance will be borne by the individual without any tax relief for that portion of the payment. The tax treatment of medical insurance cost is the same for any employee of a partnership, limited liability company, or "S" corporation since the income tax consequences are passed through those entities directly to the employee. Only when the "C" corporation format is utilized will the entire medical insurance premium be deductible by the corporation and not included in the individual's income. Remembering that the difference between a "C" corporation and the other entities is that it is subject to tax in itself, as opposed to the other forms, which pass the tax consequences through to the individual owners, this could be a significant factor in choosing the type of business entity to be utilized. Of course, the availability of the 100% deduction for medical insurance by a "C" corporation is only one factor, and a goal would be to minimize any taxable income realized by the "C" corporation, by proper utilization of this and other corporate deductions and/or income tax shelters.

It is worth noting that, in a one employee corporation, i.e., the owner, or a one-family corporation (no "outside employees" to provide for), a properly drawn medical reimbursement plan can make tax-deductible some health expenses (e.g. dental care, orthodontia and optical care) for which it may be prohibitive or impossible to purchase insurance.

Although probably not on the scale of importance as the medical deduction, the treatment of automobile expenses is another decision an individual must make when forming his or her own business. If the business being formed requires the use of an automobile, consideration should be given to how this use is going to be treated as a business expense. The decision centers around whether or not an individual will use a personal vehicle for business purposes, then seek reimbursement from the entity, or have the entity own the vehicle outright and cover all the costs associated with it. Again remembering that in all entities except a "C" corporation, the income tax consequences are passed through to the individual taxpayer, the question to be decided is whether or not the business would be better served to own a vehicle and have the entire cost related to the operation of that vehicle deductible on its income tax return in the "C" corporation, or to reimburse the individual for expenses associated with the personal vehicle. From an income tax standpoint, the individual does not have a negative tax consequence with reimbursement because it is not income, but there is a negative income tax consequence where the "pass through" entities are involved since business deductions are limited for an individual. On the other hand, although the costs associated with a vehicle are entirely deductible by the corporation, it is possible that the insurance rates the corporation would have to pay on that vehicle might be significantly higher. That, of course, would have to be worked into the evaluation of alternatives.

Medical insurance and vehicle costs are just two areas that must be weighed when trying to decide which type of business entity to utilize. We would be happy to review such issues with you.

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