Tax and Business Alert - September 2002

HEALTH REIMBURSEMENT ARRANGEMENTS

An alternative health plan arrangement, on which the IRS recently released some favorable tax guidance, may now offer employers an alternative to costly health maintenance organization (HMO) and preferred provider organization (PPO) insurance plans.

Health reimbursement arrangements (HRAs) offer employers the possibility of reining in health care costs. We expect you'll be hearing more about HRAs in the near future, so we want to brief you on how they operate.

An HRA is an arrangement in which an individual health care reimbursement account is set up with a fixed annual amount for each covered employee. These accounts are similar to a health care flexible spending account (FSA) because employees can submit their out-of-pocket medical expenses and get reimbursed from the accounts. However, there's a significant difference. An FSA is funded with the employee's money that is set aside on a pre-tax basis, while HRAs must be funded solely by the employer. Payments an employer makes pursuant to an HRA are tax deductible and if some relatively straightforward rules are satisfied, any reimbursements from the accounts are nontaxable to the employees.

Any unspent money in an HRA at year-end can be carried forward from year to year until it is needed (even if the employee retires or leaves the company in the meantime). With an FSA, if an employee misjudges how much to put in the account and has some left over at year-end, the excess reverts back to the employer.

At this point you may be wondering why an employer who currently offers an FSA (funded by employee contributions) would want to switch to or add on HRA accounts (that must be funded solely by the employer). The key is what comes with the HRA.

Many employers who are setting up HRA accounts are also switching to high-deductible major medical plans. For example, let's say the plan has a $2,000 deductible for singles and a $4,000 combined deductible for a family.  An employer might put $1,000 annually into an HRA for someone who had employee-only coverage and $2,000 annually for someone with family coverage. The idea is that an employer's savings from switching from an HMO or PPO to a high-deductible plan will more than offset the cost of setting up the HRA accounts. If this works, the employer saves money.

Employees can also come out ahead with the combination of an HRA and a high-deductible plan if their total expenses for the year are less than what their employer puts in their HRA account. They're allowed to bank the excess and carry it over to a future year, In fact, this result is touted as one of the big benefits of HRAs. It gives employees a greater incentive to make cost-effective decisions when they purchase health care services, because if they exceed their HRA account balance, the next layer of medical expenses comes straight out of their pocket. Thus, the bottom line is HRA accounts have the potential to save employer's money and perhaps help lower health care costs by making employees better health care consumers. Please feel free to call us for more information.            

DOING AWAY WITH A MONEY PENSION PLAN

Prior to 2002, many taxpayers maximized their retirement plan contributions by contributing 15% to a profit-sharing plan and 10% to a money purchase pension plan. Two plans were often used to get the overall contribution limit of 25% since the limit for profit-sharing plan contributions was 15%. The downside of this arrangement is that while contributions to the profit-sharing plan are discretionary, contributions to a money purchase plan are mandatory. Thus, the money purchase plan must be funded each year regardless of whether the business made a profit.

Beginning in 2002, however, the maximum contribution to a profit-sharing plan increases to 25%. This increased rate now enables many taxpayers to maximize their retirement plan contributions using a single profit-sharing plan, which is not only simpler, but also provides more flexibility since contributions are not mandatory.

But what about existing money purchase pension plans? Terminating a plan can sometimes trigger undesirable results, including allowing all participants to immediately vest in their benefits. Fortunately, the IRS recently issued guidance on merging or converting a money purchase pension plan into a profit-sharing plan without being treated as a termination or partial termination of the plan. Provided all employees covered by the converted or merged money purchase pension plan remain covered and the money purchase pension plan assets retain their character under the new plan, the previous vesting schedule is still available.                 

LOWER SMALL BUSINESS EXPENSES

Making a profit in your small business (or most any business) is getting more difficult every day. However, there is usually room to reduce your expenses at least a little and provide some bottom line and cash flow benefit. Many businesses focus strictly on big-ticket items, but costs can be contained on smaller items too. Listed below are a few ideas on how to lower some of those smaller, day-to-day costs.

You can purchase lesser-known brands of paper, pens, and other supplies. Look for special deals on expensive items such as print cartridges and buy supplies in bulk whenever possible.

Examine whether you are paying for unnecessary equipment service contracts. Depending on the age and reliability of the machine in question, it may make more sense to pay for repairs.

Periodically ask your telephone service provider if you are eligible for a better rate, determine if your service level is too high, and look at different service plans. As always, enforce company rules on personal calls. Also check to make sure that your Internet Service Provider is the most efficient for your business and inquire about available discounts for paying fees annually.

Make sure that employees are using the most efficient shipping and mailing service, e.g., using U.S mail or e-mail when overnight mail isn't necessary.

INTERESTING WEBSITES

Whether you are a senior citizen or taking care of aging parent, the Internet can provide much needed information on how to deal with eldercare issues. The official U.S government site for Medicare is www.medicare.gov . This free site lists information on Medicare eligibility, enrollment, and premiums; nursing homes; Medicare plan choices; Medicare claims appeals, information, and Medicare summary notices; health information; and frequently asked questions.

Extensive health and wellness information is available from the National Institute on Aging at www.nih.gov/nia . This government-sponsored site can also help you locate long-term-care facilities and local assistance programs.

Concerned about maintaining or improving your vision? The American Optometric Association's website, www.aoanet.org  can help. The site offers consumers information on managed care issues, visual conditions, eye diseases, children's and sports vision issues, contact lenses, corneal modification, and nutrition.

BIGGIE-SIZE YOUR MEAL DEDUCTIONS

Most taxpayers are at least vaguely aware of the tax rule that disallows 50% of their otherwise allowable deductions for business meals. This provision normally applies regardless of the reason for the meal--from taking clients out to dinner to paying for your meals while traveling away from home. What is not as widely known is that there are several exceptions to this onerous 50% disallowance rule. When one of these exceptions applies, you generally get a 100% deduction for the business meal expenses--which might make even a good meal taste that much better.

Here's a quick rundown of the major exceptions to the disallowance rule (we're aware of more than a dozen exceptions, but some are very narrowly focused).

· The office coffee bar. Employers who provide their employees with free coffee, soft drinks, bottled water, juices, donuts, or similar snacks or beverages to be consumed on the business premises can claim a deduction for 100% of the expense.

· Employee parties. The 50% disallowance rule doesn't apply to the costs of providing food and beverages at recreational, social, or entertainment gatherings primarily for the benefit of rank-and-file employees (as opposed to highly compensated employees). Examples include company outings (such as a summer picnic) and banquets or other gatherings (such as an annual holiday party) for employees and their guests.

· Meals served on the employer's premises. In the right circumstances (which can be fairly difficult to meet), an employer may provide employees with meals at work and claim a full deduction for the costs (without the employees having to report the value of the meals in their income). The key is the meals have to be provided (a) for a valid business reason and (b) primarily for the convenience of the employer (not as an added fringe benefit for employees).

· Items available to the public. Expenses incurred for meals made available to the general public are 100% deductible. Examples include free food and beverages at concerts hosted by a shopping mall, free dinners for potential restaurant customers, free hot dogs at a car dealership or hardware store promotion, a free wine and food tasting exhibition sponsored by a liquor dealer, and free hors d'oeuvres furnished by a realtor for a client's open house.

· Amounts billed to clients. When services are provided as an independent contractor, the service provider can deduct 100% of job-related meal expenses by billing the client separately for these costs. (Obviously this isn't always practical.) The client is then stuck with the 50% disallowance rule. If separate billing doesn't occur, the 50% disallowance rule applies to the service provider.

· Charity sporting event. The allowable deduction for the cost of a ticket to a qualifying charity sporting event isn't reduced by the 50% meal disallowance rule even when meals are included. The ticket package must include admission to the event, but it can also include meals and refreshments. To qualify for this exception, the charitable event must give 100% of its net proceeds to a charity and use volunteers to do almost all the work in the event itself. The classic example is a charity golf tournament with a meal included in the deal.

· Hours of service limitations.  In lieu of the regular 50% disallowance, individuals whose work is subject to the hours of service limitations of the Department of Transportation (e.g., interstate truck drivers, certain air transportation employees, certain railroad employees) can deduct 65% of their business food and beverage expenses in 2002. The deductible percentage will increase five percentage points every two years beginning in 2004, until it reaches 80% in 2008.

As you can see, there are enough exceptions to the 50% disallowance rule that most businesses can meet one or more of them. To the extent your business qualifies for any of them, it's important that the qualifying expenses be tracked separately so that a full deduction can be claimed.

If you have any questions regarding the types of business meal expenses that may qualify for a full deduction or how to properly isolate and account for them in your records, please give us a call.               

REMEMBER THE ROTH IRA?

As we approach the end of summer, this is a great time to look for tax-advantaged investment opportunities. The Roth IRA continues to be a favorite because it has many long-term benefits, particularly for those savers and investors who qualify for rollovers from traditional IRAs.

ROTH ADVANTAGES

A Roth IRA's biggest advantage is the ability to maximize wealth in an IRA. There are no mandatory distribution rules at age 70½, and you can continue to make contributions past age 70½ (assuming that you or your spouse has earned income). Roth IRA distributions are taxable only in limited circumstances and qualified distributions are completely free of tax.

SOME ROTH IRA FACTS

For 2002 through 2004, you can contribute to a Roth IRA up to the lesser of (a) $3,000 ($3,500 for individuals age 50 or older at year-end) or (b) your compensation for the year, reduced by the amount contributed to a traditional IRA for the year. Roth IRA rollovers or conversions do not affect allowable current year contributions to traditional or Roth IRAs.

Contributions to Roth IRAs are not deductible and the maximum allowable contribution is phased out ratably over a range of modified adjusted gross income. These ranges are $150,000-$160,000 for joint filers, $95,000-$ 110,000 for those filing as single or head of household, and $0-$ 10,000 for those using the married filing separate category.

Participating in an employer-sponsored retirement plan does not prevent you from contributing to a Roth IRA. Only modified adjusted gross income in excess of the phase-out range makes you ineligible to make a Roth IRA contribution.

Like traditional IRAs, Roth IRA contributions must be made by April 15 of the following year.

CONVERTING A TRADITIONAL IRA TO A ROTH IRA

You can convert (or roll over) all or any part of an existing traditional IRA (including SEP IRAs but not SIMPLE IRAs) into a Roth IRA in any year in which your modified adjusted gross income is no more than $ 100,000. The same $ 100,000 income limitation applies to both single taxpayers and married taxpayers filing a joint return. Married taxpayers filing a separate return do not qualify for the conversion privilege at any income level.

If you roll over or convert a traditional IRA to a Roth IRA, you must include in your gross income any prior deductible contributions and all IRA earnings allocable to the converted amount. The 10% penalty on premature distributions does not apply to these converted amounts.

The benefit of making a conversion is that, although income tax is currently due because of the conversion, you can enjoy all of the future benefits of the Roth IRA.