Medical C Corp

Every so often a client arrives with a pitch: set up a C corporation, have your S Corp pay it a management or marketing fee, and let the C Corp reimburse your family’s medical bills through a health reimbursement arrangement (HRA). The S Corp deducts the fee, the C Corp deducts the medical expenses, and suddenly your out-of-pocket medical bills become fully deductible. Sounds great!

Why not have your S Corp do it directly? Because an S Corp owner with more than 2% of the stock is treated like a partner for fringe benefits (IRC Section 1372). Medical reimbursements just become extra taxable wages, and your spouse and kids are treated as owning your stock too, so putting them on payroll doesn’t fix it. You’re left deducting the bills as an itemized medical expense, which only counts above 7.5% of your adjusted gross income. Hence the second corporation.

WCG CPAs & Advisors doesn’t set these up, and here’s why-

• The fee has to buy something real. A related-party fee must purchase actual services at a commercially supportable price (IRC Sections 162(a) and 482). A C Corp whose real job is paying your medical bills isn’t providing marketing or management services, no matter how many web hosting invoices you move into it.
• Your other employees count too. If you control both corporations, the controlled group rules generally combine their employees when testing a self-insured medical reimbursement plan (IRC Section 105(h)(8)). An owner-only plan that discriminates against eligible employees can make reimbursements to the owner taxable. Creating another corporation doesn’t make those employees disappear.
• The ACA has opinions. A standalone HRA generally needs to comply with the ACA’s market reforms or qualify for an exception. A noncompliant plan can trigger an excise tax of $100 per day per affected employee (IRC Section 4980D). Plans with fewer than two current-employee participants are generally exempt, but the exception is based on actual plan participation, not simply how many employees are on payroll (IRC Section 9831(a)(2)).
• The savings shrink fast. A second entity, another tax return, payroll and benefit plan administration eat into the promised tax savings. And anything retained as taxable profit in the C Corp faces potential double taxation when eventually distributed as dividends.

Can a legitimate C Corp with real operations and a properly structured medical reimbursement plan provide tax-free benefits to its employee-owner? Absolutely, under the right circumstances. But common ownership, other employees and plan design still matter. That is a long way from inventing a marketing company just to reimburse the owner’s medical bills.

As for the medical C Corp pitch, we’ll pass. The tax tail shouldn’t wag the business dog.