Union Friendly -Using Collectively Bargained Pension Plans to Maximize Employee Benefit Plan Contributions for Closely Held Business Owners – Part 2

                                                         Medical Reimbursement Plans


In Part I of this series, I discussed the benefits of collective bargaining agreements for small business owners and professional corporations for qualified retirement planning. The ability to unionize employees allows the business owner to fully disarm the onerous non-discrimination rules of ERISA for employee benefit purposes.

The benefits of relying on the collective bargaining exemption of IRC Sec 410(b)(3)(A) is significant. The business owner is able to establish a qualified retirement plan that maximizes the amount of contribution and retirement benefit while skewing 100 percent of the contribution in favor of the business owner. Furthermore, the business owner is able to adopt other benefit plans that would otherwise be subject to discrimination testing.

From the employee perspective, the result is really not that bad either. The reality of the small business environment today is that many small businesses offer mediocre health insurance to employees and a 401(k) Plan with “no matching” from the employer. Undoubtedly, the quality of benefits under a union program is not only of higher quality but at a lower cost to the employer. Believe or not, it is a “win-win” situation.

As a result of recent tax reform, the top marginal bracket for taxpayers with more than $400,000 (single and $450,000 married) has increased to 39.6 percent. Taxpayers with adjusted gross income in excess of $250,000 will pick up an additional 3.8 percent on unearned income raising the top marginal bracket to 43.4 percent.

These same taxpayers will also be exposed to the phase out of personal exemptions and miscellaneous deductions. These phase outs effectively raise the marginal bracket by 1-2 percent. Taxpayers in the top marginal bracket will end up with a top federal bracket of 45.4 percent. High income states such as New York and California add an additional 8-10 percent bringing taxpayers to a combined marginal tax bracket of 53-56 percent.

Many taxpayers are unable to take itemized medical deductions on Schedule A of Form 1040 because of the new 10% of adjusted gross income floor (AGI). Additionally, medical expenses are a preference item in calculating the alternative minimum tax (AMT)

This executive summary will discuss how a business owner or owner of a professional practice can elect to cover his employees under a collectively bargained agreement IRC Sec 410(b)(3)(A) and create a medical expense reimbursement plan on a discriminatory basis.

This Code section exempts employees that are covered for retirement as well as health benefits under a collectively bargained agreement.

Collectively Bargained Arrangements under IRC Sec 410(b)(3)(A)

What is a collectively bargained agreement? IRC Sec 410(b)(3)(A) states the following in its exemption:

employees who are included in a unit of employees covered by an agreement which the Secretary of Labor finds to be a collective bargaining agreement between employee representatives and one or more employers, if there is evidence that retirement benefits were the subject of good faith bargaining between such employee representatives and such employer or employers,”

As a result, company employees pursuant to a collective bargaining agreement become union members and the business makes contributions to the union retirement and health plans instead of the company plans. These contributions to the union plan are tax deductible. As a result, these employees are no longer part of the company pension plan or benefits program.

The business owner is free to establish a define benefit plan as well as a medical reimbursement plan. The only remaining employees eligible for participation in the business owner’s plan are the business owner and family members. Benefit plan contributions can be optimized for the business owner.

What is a Medical Expense Reimbursement Plan?

IRC Sec 105 provides a small business owner with the ability to reimburse an employee and his family members for medical expenses not covered by health insurance. The business is able to deduct the reimbursement expense as a business expense while excluding the payment for the benefit of the employee without treating the payment as wages subject to income and the employer portion of FICA (7.655) and FUTA (0.8%) payments. The employee is not taxed on these reimbursement payments from the employer and not subject to the employee portion of FICA or the additional Medicare tax. .

The Medical Expense Reimbursement Plan is a contractual arrangement or plan that is subject to discrimination testing absent the collective bargaining agreement between the business and a union. The Medical Expense Reimbursement Plan requires a corporate resolution adopting the Plan as well as a Summary Plan Description.

The range of medical reimbursements can be quite comprehensive including dental and vision -related treatment expenses. The reimbursements may include prescription drugs as well medical equipment and travel and lodging. Additionally, long term care is fully deductible versus partial deductibility as an individual when taken as an itemized deduction.

Generally, a C Corporation can provide reimbursements for the entire family.  A LLC would need to hire the spouse in order to provide reimbursements for the spouse.

Union Friendly – Telling the Emperor that He Has No Clothes

Inevitably, the biggest worry of every business owner or professionals when it comes to unionized employees is the fear of the union itself. Public sentiment towards unions is politically charged and divisive. Most people either love unions or hate them.

In regard implementation of this strategy, you need to see the union exemption as a means to an end – a comfortable retirement, lower taxation and maximization of all of the available benefit plan strategies that make sense. . You need to take off your “political hat” to evaluate this potential economics of this strategy.

Most business owners assume the worst believing that long term employees who join the Union on Friday will be outside of the business picketing the following Monday for higher pay and paid vacations as well as becoming members of the communist party.

The key to this strategy is working with “friendly” unions and maintaining an ongoing stable relationship. Most “friendly” unions need members and have no interest tampering with the small business.

The strategy below illustrates the possible benefits of the strategy.

Strategy Example


John Jones, age 50, is a general contractor and owner of Acme Contracting, Inc. He has a salary of $500,000 but also has 50 employees in the business. The company is a regular corporation.  The company provides a high deductible health insurance plan and has shifted from employer-pay-all coverage to a situation in which employees now pay 50 percent of the coverage. Additionally, the company has a 401(k) plan. The company use to match dollar-for-dollar up to six percent of salary; however, the company no longer does any matching. Contribution testing also limited the ability of John to fully utilize the deferral opportunity for himself under the 401(k) plan.

John’s wife Mary had Stage 3 breast cancer last year and continues to receive treatment. The medical expenses that are not reimbursed for her treatment amount to $15,000. His son has ADHD and the treatment is not fully covered by insurance. The total amount of unreimbursed medical expenses in a given year amounts $35,000. John has not been able to deduct these expenses.

Strategy Example

Acme enters in to a collective bargaining agreement with the local chapter of the A.F.L-C.I.O Union. Each employee will pay union dues of $28 per month which will be reimbursed by Acme.

The employees will be covered for retirement and health insurance purposes under the union plan. The health insurance contributions for the employees are similar in cost to the current plan.  However, the new coverage has no deductible and provides for much better coverage than Acme’s existing plan. The union also provides a 401(k) plan.

Acme is able to establish a new defined benefit plan covering John. A fully insured defined benefit plan option funded with annuities only provides for a combined tax deductible contribution of 325,000 in Year 1. The plan targets the maximum retirement benefit of $205,000 per year beginning at age 65.

John is able fully fund their 401(k) with contributions of $23,000 each ($17,500 max contribution in 2013 plus a $5,500 catch up for participants that are older than age 50). He is also contributing to a profit sharing plan in an amount equal six percent of the maximum annual compensation limit, $255,000. Their profit sharing contribution is $15,300. John’s combined qualified pension contributions is approximately $363,500.

Acme adopts a medical reimbursement expense plan. John’s medical reimbursements are fully deductible to Acme and not subject to FICA and FUTA withholding taxes for Acme. The medical reimbursements are not taxable to John and are not subject to FICA and the additional Medicare tax (0.9%) withholding taxes.

Additionally, John and his wife purchase long term care insurance which is paid for by Acme. The premiums are fully deductible and not taxable to John personally.


The ability to maximize the ERISA exemption for collectively bargained agreements provides the opportunity to streamline benefit costs for employees while maximizing contributions for the business owner. The high cost of medical insurance plus the amount of medical expenses that are not covered by insurance continues to increase for business owners.

A Medical Reimbursement Plan has excellent tax and financial benefits for the small business owner and his family. The collective bargaining exemption is a pathway for a small business owner to regain the High Ground in the tax battle against small business owners while providing meaningful benefits for the business owner.


About gerrynowotny

I am a tax and estate planning attorney with a JD and LL.M in estate planning from the Univesity of Miami School of Law. I have worked in the life insurance industry for twenty three years and the last eleven in private placement life insurance.
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