On February 18, 2000 and on January 26, 2007, the Internal Revenue Service (IRS) issued Private Letter Rulings (PLR) 200007025 and 200704017 respectively.  The issue before the IRS was whether the partnership’s self-insured medical plan was an arrangement having the effect of accident or health insurance.

As a general rule, partners are treated as self-employed rather than as employees for income tax purposes.  In addition, under IRC Section 1372, S corporation shareholders who own more than 2% of the stock are treated the same as partners of a partnership for fringe benefit purposes.

In PLR 200704017, the IRS ruled that a self-employed individual may deduct premium payments to a self-funded health plan, and is not required to include reimbursements from the plan in gross income.  According to the IRS, they reached this conclusion because the health plan had the characteristics of insurance.  The major point made by the ruling was that the self-funded plan adequately shifted risk among plan participants.  The ruling states that the risk shifting will occur when an insurer agrees to protect the insured against an economic loss in exchange for the payment of a premium by the insured. 

Based on the specific facts presented, the IRS ruled that partners can deduct premium payments to their partnership’s group health plan and exclude benefit payments from their gross income as long as the plan has the effect of accident or health insurance. 

Under IRC 104(a)(3) payments of medical expenses should be excludable from income as long as they are treated as received through accident or health insurance or an arrangement having the effect of accident or health insurance (and that is not merely a reimbursement arrangement).  Under IRC 162(1) premium payments made by individual partners for coverage under the Plan will be deductible by them, subject to limitations of that provision. 

In PLR 200007025, the IRS also ruled that a self-employed individual may deduct premium payments to a self-funded health plan, and is not required to include reimbursements from the plan in gross income.

In PLR 200007025, the IRS noted that “the language “or through an arrangement having the effect of accident or health insurance)” in section 104(a)(3), was added to the Code by section 311 of the Health Insurance Portability and Accountability Act of 1996 (HIPAA), 1996-43 I.R.B. 7, effective for taxable years beginning after December 31, 1996.  HIPAA Section 311 also increased the amount of the deduction under section 162(I)(1)(A) of the Code.  The legislative history of section 311 “Increase in Deduction for Health Insurance Costs of Self-Employed Individuals”, states that under present law, self-employed individuals are entitled to deduct 30 percent of the amount paid for health insurance for the self-employed individual and the individual’s spouse and dependents.  The 30 percent deduction is available in the case of self-insurance as well as commercial insurance”.   In order for the exclusion to apply, the arrangements must be insurance and there must be adequate risk shifting, i.e., insurance must shift the risk of economic loss from the insured to the insurance program and must distribute the risk of loss among the participants.

These rulings are significant because partners are not “employees,” and thus they are not eligible for the IRC 105(b) gross income exclusion of medical expense reimbursements or the IRC 106(a) gross income exclusion for employer-provided health coverage.  Also unlike employees, partners may not pay group health insurance premiums on a pre-tax basis through IRC 125 cafeteria plans.

Although a Private Letter Ruling (PLR) applies only to the party to whom it is addressed, a PLR provides an indication of how the IRS interprets certain issues. 

For copies of the Private Letter Rulings click on the links below:

http://66.77.65.231/pub/irs-wd/0007025.pdf

http://www.irs.gov/pub/irs-wd/0704017.pdf