A Health Savings Account for every business — and owner

Jan. 1, 2008
The ever-escalating cost of health care and medical insurance has long been a problem for dental equipment and supply businesses and their owners.

by Mark E. Battersby

The ever-escalating cost of health care and medical insurance has long been a problem for dental equipment and supply businesses and their owners. The inability of small employers to offer medical insurance is often blamed when they cannot attract and retain skilled workers.

In recent years, President Bush has proposed a number of solutions to this problem, and both the president and congressional leaders advocate plans to make health care and insurance more affordable. Now the talk of so-called “universal health coverage,” government-run medical insurance, may force dental equipment and supply businesses to provide health insurance to their employees.

Thanks to our tax laws, medical insurance coverage and the cost of health care may already be an affordable option for many dental equipment dealers and business owners. Our tax laws currently allow the self-employed operators of many businesses to deduct, in full, amounts paid for medical insurance for themselves, their spouse and dependents. This deduction is also available to partners and shareholders of pass-along businesses such as S corporations. Best of all, health insurance premiums are deducted from gross income, off the top, without the 2 percent floor for itemized deductions.

Of course, there has to be adequate income from which to deduct these expenses. Fortunately a unique plan, Health Savings Accounts (HSAs), similar to Individual Retirement Accounts (IRAs), help reduce health insurance costs using high deductible insurance coverage.

HSAs allow every plan holder to contribute funds that can later be withdrawn to pay medical expenses. These plans utilize contributions of pre-tax dollars, made before computing the tax bill, as do IRAs. The tax write-off for self-employed insurance is, at best, only a partial answer for many dental equipment dealers. Fortunately, HSAs may be used with low cost, high deductible insurance, with an accompanying tax deduction for the dental equipment and supply business.

What is an HSA?

The question of affordable health insurance has troubled many small business owners. According to researchers at Information Strategies Inc., a Ridgefield, N.J.-based marketing and publishing company, the average amount an employer pays for health insurance has gone from about $4,000 per employee in 2000 to an estimated $8,000 per employee in 2006.

According to many experts, allowing small businesses to participate in a small health plan is an important step toward helping the 44.8 million uninsured Americans. Not too surprisingly, recent figures show that over 60 percent of uninsured employees work for small businesses.

HSAs insured an estimated 7.4 million Americans last year. HSAs are a relatively new option, available to every dental equipment and supplies business owner seeking health care insurance for themselves and their families or affordable options to offer employees. The Medicare Prescription Drug Improvement and Modernization Act of 2003 contained the provision that permits eligible individuals to establish HSAs.

Imagine saving for future medical expenses on a tax-free basis. That’s right. HSAs are a tax-free way to save for medical and retirement health expenses. Money funneled into an HSA uses funds before the tax bill is computed. Account holders can withdraw money tax-free for qualified medical care. They can also let the money add up tax-free until retirement, and pay income tax on any withdrawals after that.

Tax favored and tax-free

Those who pay medical expenses spend dollars that remain after taxes have been withheld or paid. When pre-tax dollars are used — dollars that have not been reduced by the bite of taxes — it is called “tax favored.”

Today almost everyone can benefit from an HSA, which is created to receive so-called “tax-favored” contributions by or on behalf of eligible individuals. Amounts paid into an HSA may be accumulated over the years or distributed on a tax-free basis to pay qualified medical expenses.

Think IRA. When an employer contributes to an employee’s IRA, the contributions are generally tax deductible by the employer. Those employer contributions do not increase the tax bill of the employee. Contributions made directly by the individual may be excluded from his or her income. In every case, the income from the funds remaining in those accounts stays within the IRA without affecting the individual’s tax bill.

Either individuals or their employers can establish HSAs to reimburse qualified medical expenses paid during the year. These accounts allow taxpayers with high deductible health insurance to make pre-tax contributions of up to $2,850 for self-employed coverage, $5,650 for family coverage.

Amounts are excluded from gross income if paid or distributed from an HSA that is used exclusively to pay the qualified medical expenses of the account beneficiary, his or her spouse or dependents. Excess distributions are, of course, subject to income tax as well as a 10 percent penalty, unless made after the beneficiary reaches age 65, dies or becomes disabled.

HSA contributions made by a partnership or S corporation to a partner or shareholder’s HSA are generally treated as payments to the partner or shareholder and are included in gross income. The individual partner or shareholder usually treats the contributions as an above-the-line deduction.

However, a contribution to the partner’s HSA by the partnership for services rendered is usually treated as a guaranteed payment and the partnership may deduct the contribution as a business expense. Similarly, a contribution by the S corporation to a 2 percent shareholder’s HSA for services rendered is deductible by the S corporation and included in the shareholder’s income.

Qualified medical expenses are generally the same expenses that qualify for the medical expense deduction. Premiums for long-term care and coverage during periods of unemployment, whether or not through COBRA, also qualify.

Highly deductible requires a high deductible

When the new rules refer to a HDHP (high deductible health plan), they mean a health plan that requires high deductibles and out-of-pocket expenses. A high deductible health plan is defined as a plan that has at least a $1,000 annual deductible for self-only coverage and a $2,000 deductible for family coverage. In addition, annual out-of-pocket expenses paid under the plan must be limited to $5,000 for individuals and $10,000 for families.

These amounts are indexed annually for inflation. For 2007, the minimum deductible is $1,100 for individual coverage and $2,200 for family coverage. The out-of-pocket expense maximum is $5,500 for individuals and $11,000 for families.

Out-of-pocket expenses include deductibles, co-payments and other amounts (other than premiums) that must be paid for plan benefits.

The self-employed option

Even before the Medicare law was signed, existing tax law permitted self-employed dealers and sales professionals to deduct amounts paid for health insurance premiums. Today, self-employed dealers and sales professionals may deduct from their gross income 100 percent of amounts paid during the year for health insurance for themselves, spouses and dependents.

The deduction is limited to the taxpayer’s net earned income derived from the dental equipment and supplies business for which the insurance plan was established, minus the deduction for 50 percent of the self-employment tax and/or for contributions to a Keogh, self-employed SEP or SIMPLE plan. Amounts eligible for the deduction do not include those paid during any month or part of a month that the self-employed dealer was eligible to participate in a subsidized health plan maintained by their employer or the spouse’s employer.

An HSA in every pot

HSAs may not be at the forefront of President Bush’s proposal for health care reform, nor are they a key ingredient of the “Small Business Health Plans” that many organizations and professional groups have been lobbying so hard for. They may, however, be a boon to employers facing mandatory health insurance plans currently in place in Massachusetts and Connecticut, soon to become a reality in California and being studied in several other states.

California’s plan, like the Massachusetts and Connecticut plans, would require all California residents to have health insurance. To reach that goal, employers with 10 or more employees would be required to offer employees coverage or be assessed a fee equal to a percentage of their payroll. Although coverage for the poor under all of these plans is generally free, all other residents would be required to buy health coverage through state-run insurance pools or be fined.

HSAs provide another option in the arsenal of weapons available to every dental equipment and supplies business owner fighting the high costs of health care. Their flexibility permits every dental equipment and supplies business owner to benefit while contributing funds to the HSAs of their employees — with the accompanying tax breaks, of course.