8.  Farms and medical reimbursement plans (Shellito v.Comr.)

An important case on Section 105 Plans came out of Kansas in 2010.

Such plans “are used primarily by sole proprietorships. We see them heavily used by sole proprietorship farming operations so you can employ the spouse in the business and provide a medical reimbursement plan for the spouse as a fringe benefit. So, it gets a … business deduction and the employer-spouse can be covered under the plan, as well as the rest of the family. Amounts reimbursed aren’t included in the employee-spouse’s income.

“Well, it must be set up correctly.

“A key thing about this case was (the farming family) did everything correctly. They employed the spouse, paid a wage, issued a W-2, withheld tax, kept a daily log book of the spouse’s activities, had a job description, all of that in writing and done properly.”

Still, the IRS “came after them on a couple of points. The IRS thought it important that the employee spouse was referred to as ‘housewife’ on the tax return and that she was paid a small wage in comparison to the amount of medical being reimbursed.

“Frankly, those two issues shouldn’t matter from a tax standpoint. But the tax courts agreed with the IRS and said they did. It went to the issue of the spouse not really being a bona fide employee in the court’s opinion. I think the court is wrong.”

The case is now on appeal.