Example of a Simple 105 HRA
Bob Jones owns an auto repair business. Bob pays himself a salary of $36,000, plus $20,000 in distribution income per year. Bob pays federal, state, and FICA (Social Security & Medicare) tax on his $36,000 salary, and he pays federal and state tax on his distribution.
Bob pays $500 per month for health insurance and roughly $3,000 per year in non-insured medical expenses. Prior to establishing a SIMPLE 105 HRA, Bob was able to deduct 100% of his family's health insurance premiums on his 1040. This deduction resulted in federal (15%) and state (5%) tax savings of approximately $1200.
Bob's business adopted a SIMPLE 105 HRA. In order to gain a tax savings using the HRA, the following changes were made:
- Bob restructured his $36,000 salary to include his family's health expenses. Assuming the above health expenses are the same, his monthly salary would remain at $3,000, and the entire $3,000 would still be subject to federal and state income taxes. He included $750 of his family's monthly health expenses as part of his $3,000 wage, and his FICA tax is now calculated on $2,250 (rather than $3,000), increasing his take home pay by $57.38 per month. This is half the tax savings; the other half is realized when his corporation no longer has to match the FICA/FUTA it did not withhold. Bob will realize a $114.75 monthly savings in FICA/FUTA tax through the use of a SIMPLE 105 HRA in his business.
- Bob must change the way he reports his income on his quarterly 941. In the past, he reported $9,000 ($3,000 x 3 months) as subject to Social Security and Medicare tax. Now he reports only $6,750 ($2,250 x 3 months), this reduces his Social Security and Medicare tax.
- Bob reports his $9,000 HRA benefit and his $27,000 salary on line 7 of his 1120S.
- Bob's W-2 must be adjusted as well; since part of his income is no longer subject to FICA tax, Box 1 remains the same as in previous years ($36,000). Boxes 3 & 5 however, are reduced to ($27,000). Bob will also report the $9,000 HRA benefit in Box 14, as other income, to verify to the IRS that the $9,000 is not subject to FICA/FUTA tax.
Since $9,000 of Bob's compensation is no longer subject to Social Security tax, ($9,000 x 12.4%) he saves $1,116. He also saves $261 in Medicare tax ($9,000 x 2.9%) for a combined SIMPLE 105 HRA savings of $1,377.
Bob will continue to deduct his health insurance premiums on the line labeled self-employed insurance deduction of his 1040 since this personal deduction gains him a federal and state tax savings only.