Section 105 Plans: How a Family Business May Deduct Health Coverage
A properly designed Section 105 medical reimbursement plan can help some small-business owners turn family health insurance premiums and other qualifying medical costs into a business deduction. The classic example involves a sole proprietor who employs a spouse, but the arrangement must reflect real employment, follow a written plan, and fit current health-plan rules.
Short answer: if one spouse owns a sole proprietorship and the other spouse is a bona fide employee, the business may be able to reimburse the employee-spouse for qualifying medical expenses covering the employee, the owner, and eligible family members. The business generally deducts the reimbursements, while properly qualified reimbursements are generally excluded from the employee-spouse’s income under Internal Revenue Code Section 105(b). This is not automatic, and it is not the same result for an S corporation shareholder.
Best-known use: A sole proprietor employs a spouse who performs real, necessary work and adopts a formal reimbursement plan.
Potential benefit: Eligible family medical costs may become a business expense instead of a limited Schedule A itemized deduction.
Main risk: A paper-only job, discriminatory plan, missing substantiation, or plan design that conflicts with ACA requirements.
Accurate as of August 2026. Health reimbursement arrangements are highly fact-specific; plan documents and employee eligibility should be reviewed before reimbursements begin.
Who this is most relevant for
This strategy is generally most relevant for profitable sole proprietors, or single-member LLCs taxed as sole proprietorships, who employ a spouse and do not have other employees. It may allow the business to deduct eligible family health insurance premiums and medical expenses through a properly structured Section 105 plan.
How does a Section 105 plan create a family health deduction?
Section 105 addresses amounts an employee receives through an employer accident or health plan. When the requirements are met, Section 105(b) generally allows an employee to exclude reimbursements for medical care incurred by the employee, the employee’s spouse, and eligible dependents.
For a family business, the planning opportunity often starts with two different roles. One spouse owns an unincorporated business. The other spouse performs legitimate services as an employee. The business adopts a written medical reimbursement plan for the employee-spouse and reimburses properly substantiated expenses according to the plan.
Because the employee’s spouse is the business owner, qualifying family coverage can include expenses benefiting the owner-spouse as a member of the employee’s family. The business may generally deduct the plan reimbursements as an employee benefit expense, and qualifying reimbursements generally are not taxable wages to the employee-spouse.
There is a second, quieter benefit. Because the reimbursement is deducted on the business’s Schedule C, it can reduce both federal income tax and self-employment tax. The self-employed health insurance deduction generally reduces income tax but does not reduce net earnings from self-employment. At the 15.3% self-employment tax rate, moving $22,000 of qualifying costs to a properly structured Section 105 plan could reduce self-employment tax by as much as $3,366 before considering the Social Security wage base, the deductible portion of self-employment tax, and other limitations.
The key idea: the owner is not deducting personal medical bills merely because they own a business. The business is providing a documented employee health benefit to a genuine employee, and the owner receives coverage as that employee’s spouse.
Example: deducting family health coverage through a spouse-employee
Assume Maya operates a profitable consulting business as a sole proprietor. Her husband, Daniel, works 15 hours per week handling scheduling, billing follow-up, document management, and vendor coordination. His duties are necessary, his compensation is reasonable, and the business keeps time and payroll records.
The business adopts a written Section 105 medical reimbursement plan covering Daniel. During the year, the family pays $18,000 of health insurance premiums and $4,000 of other qualifying medical, dental, and vision expenses. Daniel submits documentation, and the business reimburses $22,000 in accordance with the plan.
Illustrative federal result
| Item | Amount |
|---|---|
| Family health insurance premiums | $18,000 |
| Other eligible medical expenses | $4,000 |
| Total plan reimbursement | $22,000 |
The sole proprietorship may generally deduct the $22,000 as an employee health-plan expense. If the plan and reimbursements qualify, Daniel generally excludes the $22,000 from income. Maya does not also claim the same costs as a self-employed health insurance deduction or Schedule A medical deduction.
Compare that with paying the same costs personally. Health insurance premiums may qualify for the self-employed health insurance deduction, subject to its limits, but other unreimbursed medical expenses generally help on Schedule A only to the extent total eligible expenses exceed 7.5% of adjusted gross income and the taxpayer itemizes. A properly implemented Section 105 arrangement may therefore provide a broader business-level deduction.
This illustration is intentionally simple. The actual result depends on ownership, employee population, wages, insurance source, premium tax credits, eligible family members, plan terms, and whether the arrangement complies with current federal health-plan rules.
What must be in place before the strategy works?
The spouse-employee arrangement must be real. A title on paper is not enough. The employee-spouse should perform necessary services, receive reasonable compensation, and be treated consistently with the business’s payroll and employment obligations.
A defensible file usually includes:
- a written job description and employment agreement;
- time records and evidence of completed work;
- reasonable wages for the duties performed;
- a written plan document defining eligibility and reimbursable expenses;
- proper notice and plan-administration procedures;
- receipts, explanations of benefits, premium statements, and proof of payment;
- reimbursement from the business account; and
- records preventing the same expense from being deducted or reimbursed twice.
The reimbursement should follow the plan. It should not be an unsupported year-end journal entry created after the family already paid personal bills. Claims should be submitted and reviewed, reimbursements should match eligible costs, and private medical documentation should be handled appropriately.
Nondiscrimination and other employees matter
Section 105(h) limits favorable tax treatment when a self-insured medical reimbursement plan discriminates in favor of highly compensated employees. If the business has other employees, it generally cannot cover only the owner’s spouse without analyzing eligibility, benefits, permitted exclusions, and nondiscrimination rules.
That is why the spouse-only example is often discussed for a business with no nonfamily employees. Once a business has additional employees (or related businesses that may be treated as a single employer), the plan needs a broader compliance review.
When does the Section 105 family strategy change?
An S corporation owner is not treated like a regular employee
A shareholder who owns more than 2% of an S corporation generally is not treated as an employee for the normal tax-free fringe-benefit exclusion. Family attribution rules can also cause a spouse to be treated as a more-than-2% shareholder even when the spouse owns no shares directly. That means the classic sole-proprietor/spouse-employee Section 105 result usually does not carry over cleanly to an S corporation.
An S corporation can still pay or reimburse a more-than-2% shareholder’s health insurance premiums and deduct the amount, but the premiums generally must be included in Box 1 of the shareholder-employee’s Form W-2. If the coverage and reporting requirements are met, the shareholder may then qualify for the self-employed health insurance deduction. That is a different mechanism from tax-free Section 105 reimbursements.
Partners and sole proprietors cannot reimburse themselves as employees
A sole proprietor is not their own employee, and a partner is generally treated as self-employed rather than as an employee of the partnership. The family strategy depends on an actual employee-spouse relationship or another compliant employee arrangement; an owner cannot simply adopt a plan and submit personal bills to themselves.
ACA rules can restrict reimbursement of individual policies
An arrangement that reimburses individual health insurance premiums can be treated as a group health plan. Stand-alone employer payment plans may violate Affordable Care Act market-reform requirements unless a recognized structure or exception applies. One-participant plans covering fewer than two current employees may receive different treatment, but the employee count and related-employer rules must be confirmed.
Businesses that want to reimburse individual insurance for a broader workforce may need a compliant Qualified Small Employer Health Reimbursement Arrangement (QSEHRA) or Individual Coverage HRA (ICHRA), rather than an informal premium-reimbursement practice. A QSEHRA has eligibility, notice, coverage, and annual reimbursement-limit rules. For 2026, the IRS reports maximum QSEHRA reimbursements of $6,450 for self-only coverage and $13,100 for family coverage.
Do not improvise premium reimbursement: writing checks for employees’ individual insurance without choosing the correct plan structure can create federal excise-tax exposure. Plan design should come before payment.
How does California treat wages paid to a spouse-employee?
California gives this arrangement an extra advantage that national guidance misses. Wages a sole proprietor pays to a spouse are exempt from California Unemployment Insurance (UI), Employment Training Tax (ETT), and State Disability Insurance (SDI) under California Unemployment Insurance Code Section 631. The wages remain reportable as California Personal Income Tax (PIT) wages and remain subject to PIT withholding.
The exclusion is specific to the unincorporated owner. It does not apply once the employing entity is a corporation or limited liability company, even if one person or a married couple owns the entity. A California business should confirm its legal employer before relying on the family-employment exclusion.
Section 105 plan vs. the other ways to cover premiums
The right tool depends on entity type, whether there is a bona fide spouse-employee, whether the business has other employees, and how the family buys coverage.
| Approach | Who it fits | How premiums are treated | Reduces SE tax? | Key limit |
|---|---|---|---|---|
| Section 105 spouse-employee plan | Sole proprietor with a bona fide spouse-employee and no other employees | Premiums and eligible medical costs reimbursed and deducted as a business expense | Yes, deducted on Schedule C | Requires genuine employment, a written plan, substantiation, and nondiscrimination compliance |
| Self-employed health insurance deduction | Self-employed owner with no spouse-employee | Premiums deducted above the line | No | Limited to net self-employment earnings; premiums only, not other out-of-pocket medical costs |
| QSEHRA | Employer with fewer than 50 full-time-equivalent employees and no group plan | Reimburses individual premiums and medical costs tax-free | Not applicable (W-2 employees) | 2026 cap of $6,450 self-only and $13,100 family; must be offered to all eligible employees on the same terms |
| ICHRA | Employer of any size | Reimburses individual coverage tax-free; no dollar cap | Not applicable (W-2 employees) | Must meet ACA affordability and class rules; no premium tax credit if the offer is affordable |
What expenses may a Section 105 plan reimburse?
The written plan controls, but eligible expenses generally draw from the medical-care definition in Internal Revenue Code Section 213(d). Depending on the plan, reimbursable costs may include:
- health, dental, and vision insurance premiums;
- deductibles, copayments, and coinsurance;
- medical, dental, and vision care;
- prescription medications and insulin;
- eyeglasses, contact lenses, and hearing aids;
- certain qualified long-term-care premiums, subject to limits; and
- other expenses that primarily diagnose, treat, mitigate, or prevent illness.
General wellness purchases, cosmetic procedures without a qualifying medical purpose, and expenses already paid by insurance or another tax-favored account generally do not qualify. The plan should also coordinate with HSAs, FSAs, premium tax credits, and any other coverage so the family does not receive two tax benefits for the same expense.
How should an Orange County business owner evaluate the idea?
Start with the business facts, not the desired deduction. Identify who owns the business, whether the spouse already performs meaningful work, whether there are other employees, and how the family obtains health insurance. Then compare a Section 105 plan with the self-employed health insurance deduction, an S corporation health-insurance arrangement, a QSEHRA, an ICHRA, or conventional group coverage.
California payroll, wage, workers’ compensation, and insurance rules still matter even when the federal tax treatment is favorable. A spouse should not be added to payroll solely as a label; the employment arrangement and compensation should reflect the work actually performed.
Our business tax planning process looks at the plan together with entity structure, payroll, health coverage, and the family’s overall tax return. If you are considering employing a spouse, our guide to the tax benefits of hiring family members explains the related payroll foundation.
Bottom line
A Section 105 plan can be a valuable tool for a family business, particularly when a sole proprietor has a spouse who is already doing real work. Properly structured reimbursements may allow the business to deduct family health premiums and other eligible medical expenses while the employee-spouse receives the benefit tax-free.
The result depends on much more than naming the arrangement. Employment must be genuine, the plan should be written and administered consistently, expenses must be substantiated, and the design must account for other employees, entity ownership, nondiscrimination, ACA rules, and double-deduction limits.