Site Updated for 2013

Questions about health care reform and taxes?

10 Oddball Tax Deductions

10 Tax Deductions You're Not Taking

Red Flags That Trigger an IRS Audit

The Top Tax Myths

Deducting S corporation Health Insurance Premiums

Notice 2008-1

Notice 2008-1 contains the rules (and examples) for deducting accident and health insurance premiums by a more-than-2% shareholder/employee of an S corporation.

Section 1372(a) provides that, for purposes of applying the income tax provisions of the Code relating to employee fringe benefits, an S corporation shall be treated as a partnership, and any 2-percent shareholder of the S corporation shall be treated as a partner of such partnership.

Definition of a 2% Shareholder

The following is from IRS Notice 2008-1:

For purposes of § 1372, the term "2-percent shareholder" is any person who owns (or is considered as owning within the meaning of § 318) on any day during the taxable year of the S corporation more than 2 percent of the outstanding stock of such corporation or stock possessing more than 2 percent of the total combined voting power of all stock of such corporation.

How an S corporation Deducts Health Insurance Premiums

An S corporation deducts the premiums it pays for accident and health insurance to cover a 2% shareholder/employee (and his/her spouse and dependents) as compensation paid to the shareholder/employee. In other words, the premiums are included in the shareholder/employee's salary and reported on the individual's W-2 form.

Notice 2008-1 states that health insurance premiums paid or furnished by an S corporation on behalf of its 2 percent shareholders in consideration for services rendered "are treated for income tax purposes like partnership guaranteed payments under § 707(c) of the Code. Rev. Rul. 91-26, 1991-1 C.B. 184."

Health Insurance Premium Deduction Rules

The rules that apply to S corporations also apply to:

  • Partnerships and
  • Multi-member LLCs (but not to a single-member LLC)

Plan Must be Established By the Business:

If you're a more-than-2% shareholder/employee in an S corporation, a partner in a partnership, or a member in a multi-member LLC, you may only deduct health insurance premiums directly on Form 1040, line 29 if the the health insurance plan is considered to have been established by the business and not by you personally.

Whether you or the business are considered to have established the plan depends on two things:

  1. Who actually pays the premiums
  2. How the premiums are reported for income tax purposes by both you and the business

In other words, it's not whose name the policy is in that determines who established the plan. It may be in your name or the business's name. Instead, it is who actually pays the premiums and how the premiums are reported for tax purposes that determines who established the plan.

Any One of Three Scenarios Must Be Satisfied

For an accident and health insurance plan to be considered established by the business, any one of the following three scenarios must apply:

Scenario 1:

The business obtains an accident and health insurance policy in the business's name to cover its more-than 2% shareholder/employees (in the case of an S corporation), partners (in a partnership), and members (in a multi-member LLC). The plan also covers their spouses and dependents:

In this scenario, the plan is established by the S corporation.

Each 2% shareholder/employee, partner, and LLC member may take the deduction on Form 1040, line 29.

For example, if the business paid $1,000 in health insurance premiums on your behalf, you would report the $1,000 in your gross income on Form 1040 and you may deduct the $1,000 on Form 1040, line 29.

If you were a more-than-2% shareholder/employee of an S corporation, the $1,000 in health insurance premiums paid on your behalf would be included in your W-2 as part of your gross wages. If you were a partner in a partnership or member of a multi-member LLC, the $1,000 would be included in your Schedule K-1 as guaranteed income.

Scenario 2:

A more-than-2% shareholder/employee, partner, or member of a multi-member LLC obtains an accident and health insurance policy in his/her name:

In this scenario, the plan is established by the business even though the policy is not in the business's name. The premiums paid by the business may be deducted on Form 1040, line 29.

Scenario 3:

A more-than-2% shareholder/employee, partner, or member of a multi-member LLC obtains a policy in his/her name to cover himself his spouse and two children

In this case, the health insurance plan is considered established by the business even though the plan is not in the business's name because the business reimbursed the premiums to the 2% shareholder/employee, partner, or LLC member..

The 2% shareholder/employee, partner, and LLC member may deduct the premiums paid on Form 1040, line 29.

When a 2% S corporation Shareholder, Partner, or LLC Member May Not Claim the Deduction on Form 1040, Line 29:

Here's a situation where health insurance premiums may not be deducted directly on Form 1040, line 29:

In this case, the plan was not established by the business because the business did not pay any of the premiums nor did the business reimburse the premiums to the 2% shareholder/employee, partner, or LLC member..

The premiums may not be deducted on Form 1040, line 29. Instead, the deduction may only be claimed on Schedule A as an itemized deduction as a medical expense. Starting in 2013, to get a tax benefit, total medical expenses must exceed either 10% of adjusted gross income (AGI) if the taxpayer is under 65 years old or 7 1/2% of AGI if the taxpayer is 65 or older.

Caution!

Do not include amounts for any month you were eligible to participate in an employer-sponsored health plan (Section 162(l)(2)(B)) or amounts paid from retirement plan distributions that were nontaxable because you were a retired public safety officer.

You cannot claim the health insurance premium deduction if you file Form 1040A or Form 1040EZ.

Earned Income From Trade or Business Limitation

The deduction for health insurance premiums is not allowed to the extent that the amount of the deduction exceeds the earned income derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established.

Amended Returns

Taxpayers who did not claim the health insurance deduction on a prior year's return may file an amended return on Form 1040X. It must be filed timely (3 years from the due date of the original return, plus extensions, or 2 years from the date the tax was paid, whichever is later).

You need to write the following at the top of the amended return:

Notice 2008-1 contains the rules (and examples) for deducting accident and health insurance premiums by a 2% shareholder/employee of an S corporation.

Run your business like a business!


3 ways to help...


QuickBooks Online - Anytime, Anywhere. Easily Track Sales, Bills and Expenses. Try Now FREE for 30 Days!

Paychex Payroll Services: Sign up Today!