The structure
A sole proprietor hires their spouse as a bona fide employee. The business establishes a Section 105 self-insured medical reimbursement plan covering employees and their families. The plan reimburses the employee's family medical expenses (premiums, copays, prescriptions, etc.). The reimbursement is deductible to the business and excluded from the employee's wages.
Why it works
Family medical expenses are usually only deductible on Schedule A above 7.5% of AGI — a high threshold. Section 105 reimbursement converts those expenses into Schedule C business deductions, dollar-for-dollar, reducing both income tax AND self-employment tax.
Required documentation
Written plan document. Bona fide employer-employee relationship (the spouse must actually work for reasonable compensation). Real wages paid (W-2 issued, payroll taxes paid on the spouse's wages). Substantiation of reimbursed expenses. Many third-party providers (BASE, TASC) offer turn-key plans for a few hundred dollars per year.
Limits
For QSEHRAs (Qualified Small Employer HRAs), the annual reimbursement is capped (about $6,150 self-only / $12,450 family for 2024). Larger reimbursements may run into ACA market reforms — get the structure right or risk excise taxes.
When it makes sense
Family with significant uncovered medical expenses (high deductibles, dental, vision, OTC items). Sole proprietor where adding a spouse as an employee is plausible. Profit margin sufficient to absorb the wages paid to the spouse (which incur payroll taxes themselves).
Where the IRS publishes guidance on this topic
The IRS publishes a layered set of free resources on most small-business tax topics: a relevant publication (usually one of Pub 334, 463, 535, 587, 946, 560, or 583), the instructions to the relevant form, the "Small Business and Self-Employed Tax Center" landing pages on IRS.gov, and the Audit Techniques Guides written for IRS examiners. Reading the agency's own materials is the cheapest tax education available. They are written in plain English, updated annually, and they reflect exactly the framework an examiner will apply if your return is selected.
How experienced filers approach this
Experienced self-employed filers and the CPAs who advise them treat this question as a recurring planning exercise rather than a one-time decision. They model the multi-year tax impact rather than just the current year, document the reasoning in a short workpaper that survives staff turnover and software changes, and revisit the analysis annually as facts and laws change. The discipline is not difficult — a half-day in January with last year's return, the current-year IRS publications, and a spreadsheet — but it is rare among DIY filers, which is precisely why it produces outsized results.