Medicine For The Sole

Question: We've been told a sole proprietor can set up a medical account that will reimburse medical expenses, including those of family members. We have not been able to confirm that. Where can we look?
Doug Miller
Horseshoe Bay, Texas

Answer: You are referring to Section 105 of the Internal Revenue Code. This provision permits the self-employed-including sole proprietorships, partnerships and LLCs-to deduct 100 percent of their health-insurance premiums and out-of-pocket medical expenses, a benefit otherwise limited only to C-type corporations.

To qualify, you must hire your spouse as an employee of your business. You can deduct the cost of the health insurance and a variety of noncovered medical expenses as a business deduction, and your spouse won't be taxed on those amounts.

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Because your spouse's family is covered, you're covered as well. Before doing this, however, we advise you to consult with a tax professional familiar with Sections 105, 106, 162 and Revenue Ruling 71-588 to make sure you proceed in the proper fashion.

Another option for the self-employed is a Medical Savings Account. With a Medical Savings Account, you put pretax dollars into a special account, much like putting money into a 401(k), which, if you don't need it for medical expenses, can grow tax-deferred until you retire.

However, even if you open a Medical Savings Account, you're still required to buy a high-deductible health-insurance policy through an insurer. Because the deductible is high (in 2001, from $1,600 to $2,400 for an individual and from $3,200 to $4,800 for a family), the policies cost about 25 percent less than other health

Small-business experts Paul and Sarah Edwards' latest book is Changing Directions Without Losing Your Way (Putnam Publishing Group). Send them your start-up business questions at www.workingfromhome.com or in care of Entrepreneur.