Tom Copeland Wins US Tax Court Victory for Provider
A US Tax Court judge has ruled in favor of a family child care provider who hired her husband and claimed the cost of her family's uninsured medical expenses as a business deduction. The provider, Maureen Speltz, set up a medical reimbursement plan and deducted over $7,800 in uninsured medical expenses (over 2 years). The IRS tried to deny this business deduction by raising a series of objections that the court ultimately rejected. This ruling will make it easier for providers and other self-employed business owners to establish medical reimbursement plans when hiring their spouses.
Tom Copeland represented family child care provider Maureen Speltz, from Rollingstone, Minnesota. The case (Peter F. and Maureen L. Speltz v. Commissioner of Internal Revenue, T.C. Summary Opinion 2006-25) was decided on February 14, 2006.As a result of this case, Mrs. Speltz saved about $2,000 on her taxes.
Mrs. Speltz has run her family child care business since 1982. She hired her husband, Pete to care for the children in the afternoon after he returned from work. His duties included playing with the children, lawn care, chopping firewood, repairing toys, and other activities. She did not pay him a salary but instead set up a medical reimbursement plan whereby in exchange for his services she agreed to pay the uninsured medical expenses for him and his family. (These expenses included medical insurance premiums paid by Pete through his employer, drugs, co-pays, and other items.) This plan allowed her to claim family medical expenses as a business deduction and save money on her taxes. Mrs. Speltz hired a tax advisor to set up her medical reimbursement plan.
The IRS argued that Mr. Speltz was not a bona fide employee in Mrs. Speltz's business and that the medical expenses were not an ordinary and necessary business expense.
Mrs. Speltz kept a daily record of her husband's work on a calendar (Redleaf Press' Calendar-Keeper). The court found that Mrs. Speltz had the right to control her husband's work, that his work was integral to the business, and that there was a valid employment contract between the two. The payment of medical expenses was made on account of the employer-employee relationship and not on account of the family relationship.
Mr. Speltz's primary job was to care for about five or six children for three to four hours in the afternoon. Occasionally he cared for children alone when Mrs. Speltz was at a doctor or dentist appointment or when a child arrived an hour before the normal 6am start time. He played sports with the children outdoors, went sledding with them in the winter, and took the children on nature walks along the creek next to their property. At times he took the children for rides in a trailer when he would fetch firewood (the sole source of heat for the home).
The IRS argued that the activities of Mr. Speltz were personal in nature. The court said that the hours Mr. Speltz spent picking up mail and groceries and transporting firewood without children present was not sufficiently business oriented to warrant a business deduction. But all of the other hours he spent helping out were considered legitimate business activities.
The court also rejected the IRS' argument that the amount paid to Mr. Speltz was not reasonable. He worked 517 hours in 2000 and 655 hours in 2001 and his hourly wage was approximately $6.34 - $6.50 for the two years. Since Mrs. Speltz testified that it would cost $13 an hour to hire a substitute, this wage was considered reasonable.
The IRS also claimed that Mrs. Speltz could not deduct the medical insurance premiums paid by Mr. Speltz. Normally, self-employed business owners can only deduct medical insurance premiums on Form 1040 if they are not eligible to be covered by a medical plan through another employer. In this case Mrs. Speltz was covered through her husband's medical plan. However, because of the employer-employee relationship established with her husband, the court ruled that she was entitled to deduct these insurance premiums under her medical reimbursement plan.
In a letter to Mr. Copeland, Maureen said, "Pete and I would never have been able to continue this audit through the Court, if it were not for you and Redleaf National Institute. We would not have been able to afford the cost of an attorney, and without your good-natured support, I think that we would have paid the taxes just to end the misery."With a smile, we recall the appeals officer who told us that we should replace you as our attorney with someone who was more versed in tax law!! As I told her supervisor, either the officer was wrong, or you were wrong, and I would go to tax court just to see who was. We are so pleased that you were proved correct, with no shadow of a doubt."
Lessons To Be Learned from this Case
Record keeping is important. In many cases where a provider hires her spouse, the provider does not keep proper records showing what work was done for the business and how many hours were worked. In our case Mrs. Speltz kept a daily log of the work done. This was the backbone of our case.
Medical reimbursement plan documents should be carefully prepared. We had to cope with several IRS attacks on the medical deduction because the plan documents were poorly written. One document said Mr. Speltz would work "an average of 12.5 hours a week" and another document said, "12.5 minimum hours worked weekly." This created confusion since he didn't work 12.5 hours each week. The job description read, "My duties will include lawn care, preparing firewood, fix and repair toys and sundry items, and general childcare when needed." The IRS looked at this and believed that his primary work had nothing to do with caring for children and they used this to try to argue that his work was personal, not related to the business. Job descriptions should be more carefully written to show how the work is business related.Another document said that Mr. Speltz elected to have "all or a portion of my salary $542 per month, redirected to a Flexible Spending Account to pay for uninsured and/or other health care costs." This last document unnecessarily confused things by implying that there had to be a separate account to hold the funds and that a flat amount was paid each month. In fact, the plan called for the payment of uninsured health care costs with a maximum yearly limit, not a monthly pay out.
Family child care providers should not count certain hours as business activities. Mrs. Speltz claimed hours that her husband spent on activities that should probably not have been counted. These include hours he spent food shopping, doing errands, chopping firewood and mowing the lawn. The court ruled that these hours do not count if the day care children are not with Mr. Speltz when he conducted these activities. There were times that he did shopping, went to the post office, and did household chores where day care children were with him. The court's opinion suggests that it was proper to claim these hours. In our brief we argued that as long as he was with children his hours should count because he is teaching children about real life activities. The court appeared to accept this position.
I want to thank Don Gilbo, Kathy Modigliani, Amy Baker, Lynn Manfredi-Petit, and Tom Jemison for helping me throughout this case.
Tom Copeland - www.tomcopelandblog.com
Image credit: https://www.istockphoto.com/photos/women-hand-raised
