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Malcolm and Alicia are equal partners who own Open Book, a bookstore. Malcolm, the business manager, is planning to purchase a group health plan for the business. The bookstore has four full-time employees that have no children or dependents. Based on the needs and preferences of himself, his partner Alicia, and their employees, Malcolm decides an HMO-type plan without any deductibles would be best. Before moving forward, he wants to calculate roughly how much the plan will cost the business per year, including how much it will save in income taxes.
He looks into prices and finds that HMOs in his area cost approximately $300 per month per employee. He decides the business will pay 75 percent of the premium, or $225 per month per employee ($300 x .75 = $225). He expects three of his four employees will join the plan, resulting in a monthly premium cost of $675 for all three employees ($225 x 3 = $675), or $8,100 per year ($675 x 12 = $8,100). He does not count the cost of the premium for himself or Alicia since they are considered to be self-employed, meaning that the premium costs would be a personal tax deduction, not a business deduction.
To figure an estimated tax savings from the health plan, Malcolm uses the tax rate from his previous year's personal tax return, Form 1040. He uses figures from Form 1040 rather than the partnership return (Form 1065), because partnership profits are not taxed themselves but taxed on their owners' personal returns. He sees that his previous year's taxable income (line 41) was $32,500 and that his tax (line 42) was $8,775. Dividing his tax by his taxable income shows him that his tax rate was 27 percent. Since he and Alicia are equal partners, make equal salaries and don't have income from other sources, he knows that her tax rate will be similar.
Assuming that the business income won't change so radically as to put him or Alicia into another tax bracket, Malcolm uses the 27 percent tax rate to determine what tax savings will result if the business spends $8,100 on a group health plan. Multiplying $8,100 by .27 results in $2,187. This is a good estimate of the total he and Alicia will save in taxes by purchasing the group plan for the business—or about $1,093 in tax savings for each of them.
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