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HOW THE IRS RULE WORKS

Section 105 -- Amounts Received Under Accident and Health Plans

''Amounts reimbursed under an accident and health plan covering all bona fide employees, including the owner's wife, and their families are not includible in the employee's gross income and are deductible by the owner as a business expense.''

What does this IRS-speak really mean? Although the rule explicitly states that employed spouses (simply "wives," in this case) can help a family qualify for tax-savings, few accountants are familiar with the practice, and a number of them are wary of it altogether. "If you asked 10 knowledgeable people with a reasonable level of experience about this, you'd get 10 different answers," says Rudy Deutschmann of Denver's Design Benefit Plans. With that caveat in mind, be sure to consult an accountant before trying to take the deduction.

However, consider these three criteria that must be met before the deduction even becomes feasible:

1) The business-owner must be self-employed, either as a sole proprietor, partnership, or limited liability corporation (LLC). S-corporations, which allow corporate income-and-loss benefits to flow directly to shareholders, do not qualify for the deduction.

2) It's critical that the spouse be a "bona fide" employee. The spouse can, in fact, work part-time, but he or she must have a clearly documented work record. That record can be supported by time sheets, pay stubs, and a written job description. It's also advisable to draw up a work agreement or employment contract as proof of the couple's professional relationship. Without the proper documentation, the business stands to lose the tax deduction, as well as risk investigation for tax fraud.

3) Keep in mind that a business owner offering health coverage to a spouse must extend the benefit to all other employees, as well. For a larger company that had not previously offered health insurance, the cost of insuring other employees would essentially wipe out savings from the owner's personal deduction. Even so, the discount may provide enough incentive for a business owner to offer health coverage companywide. But some owners, generally those with more than three employees, may find the deduction an inefficient means of recouping health-care costs.

By Dennis Berman in New York


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