Health Insurance Deduction for the Self-Employed

If you were self-employed during 2013 or owned more than 2% of the stock of an S corporation and the S corporation established the plan, you can deduct 100% of the premiums paid for medical and dental insurance, and qualified long-term care insurance for yourself, your spouse, and your dependents directly on Form 1040, line 29 rather than having to claim the deduction on Schedule A where it is subject to the 10% floor for taxpayers under 65 years old.

For 2013 the 7 1/2% of adjusted gross income (AGI) floor was increased to 10% for taxpayers under 65 years old. For taxpayers 65 or older, the 7 1/2% of AGI floor still applies. So, if you're under 65, your total medical expense deduction must exceed 10% of your AGI to get a tax benefit.

Where to Deduct Health Insurance Premiums

Self-employed persons and more-than-2% shareholders of a S corporation claim the health insurance deduction for premiums paid directly on Line 29 of Form 1040.

If you're a sole proprietor or a single-member LLC and you did not elect to treat the LLC as a C or S corporaton, you would be a Schedule C filer. However, you do not use Schedule C to deduct health inusrance premiums. Enter 100% of the premiums paid on Form 1040, line 29.

General partners in a partnership form of organization are considered self-employed and claim the health insurance deduction on Form 1040, line 29.

Members of a multi-member LLCare automatically treated as partners for tax purposes, and claim the health insurance deduction on Form 1040, line 29 as well. However, if an election was made to treat the LLC as a C or S corporation, then LLC member are treated as employees of the business and as being self-employed.

You cannot claim this deduction if you file Form 1040A or Form 1040EZ.

Deductible Health Insurance Premiums

Health insurance premiums include premiums paid for:

  • Medical and dental insurance for yourself, your spouse, and your dependents.
  • Qualified long-term care insurance for yourself, your spouse, and your dependents.

Who Can Claim the Health Insurance Deduction?

The following individuals may claim the health insurance deduction:

  • Sole proprietors
  • General partners
  • Limited partners receiving guaranteed payments
  • If you received wages from an S corporation in which you were a more-than-2% shareholder.

How LLC Members are Teated for Tax Purposes

Single-member LLC (SMLLC):

A SMLLC is a disregarded entity. This means, unlike a corporation or partnership, where the entity and its owners are separate legal entities, a sole proprietor and his business are legally one and the same and not separate from each other. The owner is considered self-employed.

For tax purposes, the default treatment for a SMLLC is a sole proprietorship. The LLC owner files Schedule C ( or Schedule F for farmers).

Multiple-member LLC (MMLLC):

The default tax treatment for a multiple-member LLC is a partnership. The LLC files Form 1065. Each member is issued Schedule K-1 at year end to report each member's share of the business income, deductions, credits, gains, and losses. Each member files Schedule E to report these items on his personal income tax return.

Since MMLLCs are treated as partnerships by default, and since partners are considered self-employed, members of a MMLLC are considered self-employed.

When LLC Members are Not Treated as Self-Employed

If an election is made by the owner(s) to treat the LLC as either a C or S corporation, then the owner (member) of a SMLLC or owners (members) of a MMLLC would no longer be considered self-employed. They would be treated as employees of the business the same as any other employee.

In addition, the owner of a SMLLC would no longer file Schedule C (or F) and instead, would file the tax form that applies to the entity for which the election was made. Form 1120 would be filed if C corporation tax treatment was elected. Form 1120S would be filed is S corporation tax treatment was elected.

If S corporation tax treatment is elected, each shareholder received Schedule K-1 reporting his share of the business' income, deductions, credits, gains, and losses. Each shareholder reports his share of these items on his personal income tax return via Schedule E.

S corporations report certain items separately from its profit or loss. Separately stated items retain their tax characteristics when passed through to the shareholders.

Separately stated items include:

  • Section 1231 gains and losses
  • Net short-term capital gains and losses
  • Net long-term capital gains and losses
  • Dividends eligible for the dividends received deduction (if a shareholder is a C-Corporation)
  • Charitable contributions
  • Taxes paid to a foreign country
  • Tax-exempt interest and related expenses
  • Investment income and expenses
  • Amounts previously deducted, such as bad debts
  • Real estate income and expenses
  • Section 179 deductions
  • Tax credits
  • Non-deductible expenses, such as 50% of meals and entertainment expenses

Points to Keep in Mind About Deducting Health Insurance Premiums

  • The 100% health insurance deduction is an above-the-line deduction for self-employed persons and more-than-2% shareholders of an S corporation.
    • An above-the-line deduction may be claimed even if you don't itemize your deductions. Above-the-line deductions reduce adjusted gross income.
    • If you're not self-employed or a more-than-2% shareholder of an S corporation and don't qualify to claim the health insurance deduction directly on Form 1040, line 29, you may claim the health insurance premiums you paid as medical expenses on Schedule A, if you itemize your deductions.
  • Self-employed:
    • If you are self-employed (sole proprietor or general partner), you deduct health insurance premiums on Line 29 of Form 1040.
  • Purchasing a policy:
    • Sole proprietorship:
      • If you're a sole proprietor, you may purchase a policy in your own name or the name of the business.
    • S corporation:
      • S corporation shareholders deduct the health insurance premiums on Form 1040, line 29.
      • If you're a more-than-2% shareholder of an S corporation, the plan must be "established" by the S corporation for you to qualify for the deduction.
      • To qualify for the above-the-line deduction (Form 1040, line 29), the plan must be "established" by the S corporation.
      • The plan is considered established by the S corporation even if the plan is in your own name PROVIDED:
        • The corporation pays the premiums to the insurance company OR reimburses you for the premiums you paid to the insurance company AND
        • The premiums are reported as wages on your Form W-2 and included on your individual income tax return.
    • How an S corporation handles health insurance premiums and the deduction rules for shareholder-employees.
  • Claiming the deduction:
    • The health insurance deduction may not exceed the net profit from the business under which the health insurance premiums are paid, less deductions claimed for 50% of self-employment tax and Keogh, SEP, or SIMPLE retirement plan contributions.
  • More than one business:
    • If you have more than one unincorporated business, you cannot add up the profits from each business and use that total to determine your net income ceiling.
    • Only the net income for the business for which the plan is established is considered.
  • More-than-2% S corporation shareholder:
    • If you are a more-then 2% S corporation shareholder and the S corporation has a health insurance plan, your health insurance deduction cannot be more than your wages from the S corporation.
  • If eligible to participate in an employer plan:
    • If in 2013 you were eligible to participate in any employer-subsidized plan (including your spouse's) during any month, you may not claim the deduction for any of those months.
  • Self-employment tax:
    • When computing self-employment tax, do NOT reduce net earnings from self-employment by your health insurance deduction.

The Self-Employed Advantage

An individual who is not self-employed (or not a more-than-2%  shareholder of an S corporation) does not get to deduct health insurance premiums as an above-the-line deduction on Form 1040, Line 29.

Instead, he/she must deduct health insurance premiums along with other medical expenses as an itemized deduction on Schedule A. To get a tax benefit, medical expenses on Schedule A must exceed 7.5% of adjusted gross income.

However, as a self-employed person, you get to deduct the entire health insurance premiums even if you don't itemize your deductions. You simply claim the deduction Line 29 of Form 1040.

Other Medical Expenses:

If you're eligible to claim an above-the -line deduction for health insurance premiums and have other medical expenses, such as co-payments for office visits to doctors, prescriptions, etc. of course you may claim them on Schedule A if you itemize your deductions.

Tip: Although medical expenses must exceed 7.5% of adjusted gross income for federal tax purposes, this may not apply for state tax purposes. For example, in Arizona, you can deduct 100% of medical expenses. Check with your state.

Where to Claim the Health Insurance Deduction

Claim the deduction on Line 29, Form 1040.

Sole proprietors:

Claim 100% as an above-the-line deduction.

The policy may be purchased in your own name or the name of the business.

Sole shareholder-employee in an S corporation:

According to the IRS, the above-the-line deduction is allowed only if the policy was purchased in the corporation's name.

Qualified Long-Term Care Insurance Policy for Self-Employed Persons

Part of the premium of a qualified long-term care insurance policy is deductible depending on your age at the END OF THE YEAR.

If you are self-employed, the part that is deductible is included as an above-the-line deduction on Line 29, Form 1040 along with your other medical insurance premiums.

For 2013, the maximum deductible premium for each person covered under a qualified long-term care policy is:

  • Limit on premium allowed as medical expense
    • Age 40 or under: $360
    • Over 40 but not over 50: $680
    • Over 50 but not over 60: $1,360
    • Over 60 but not over 70: $3,640
    • Over 70: $4,550

Make sure, if you are thinking about purchasing a long-term care insurance policy that it qualifies for the tax treatment explained here.

For example, the contract must:

  • Provide only for coverage of long-term care services.
  • Be guaranteed renewable.
  • Not provide for a cash surrender value.
  • Not provide that money can be assigned, pledged, or borrowed.
  • Not reimburse expenses covered by Medicare UNLESS Medicare is a secondary payer OR the contract makes per diem payments without regard to expenses.

Generally, you can exclude benefits (other than dividends) received under a qualified long-term care insurance contract from income.

However, if you receive per diem payments (payments made without regard to actual expenses), you are limited to the amount you can exclude from income.

Form 1099-LTC is issued to recipients of payments under a long-term care insurance contract.

Box 3, of Form 1099-LTC, should indicate whether the payments were on a per diem basis or reimbursements of actual long-term care expenses.

You use Form 8853 to report per diem payments and reimbursements and to determine if any of the per diem payments are taxable.