Self-employed health insurance can be a valuable deduction but it’s often missed or reported incorrectly. Here I lay out the requirements to claiming this deduction.
Eligibility
Plan Participants
§162(l)(1) allows a deduction for health insurance that covers the taxpayer, taxpayer’s spouse, taxpayer’s dependents, and children of the taxpayer who are younger than 27.
Established Under the Business
IRS Notice 2008-1 elaborates on the language in §162(l) and says that the insurance plan must be established under the business. There are two ways to meet this requirement regardless of whose name the policy is under –
- The company pays the premiums directly, or
- The company reimburses the owner for the premiums
Limitations
No Other Insurance
§162(l)(2)(B) provides that for any calendar month where the taxpayer is eligible to participate in a subsidized health plan from his employer or his spouse’s employer, he cannot claim a deduction under §162(l) for health insurance premiums.
Earned Income
§162(l)(2)(A) limits the deduction to the earned income produced from the trade or business under which the health insurance plan is established. Earned income is defined in §401(c) as net earnings from self-employment, as defined in §1402(a) with some minor exceptions.
§162(l)(5) provides that the wages of an S-corporation owner shall be treated as their earned income for the purposes of this limitation. Wages here are defined in §3121 which also defines wages for Social Security and Medicare purposes. IRS instructions to the Form 1040 say to use Medicare wages as the earned income limit for this limitation.
Reporting
S-corporation Owners
Insurance premiums paid by an employer for an employee are excluded from the employee’s wages under §106. §1372 provides that for purposes of fringe benefits, which includes health insurance, any shareholder owning more than 2% of the stock or voting power is considered a partner for these purposes. By definition, partners are not employees so S-corporation owners may not exclude these premium payments like other employees. The premiums paid or reimbursed by the company are wages for income tax purposes but not for Social Security and Medicare purposes under §3121(a)(2)(B).
The S-corporation takes a deduction for the premiums paid or reimbursed which decreases the income flowing through to the shareholders. The W-2 includes the amount of premiums paid in the Box 1 total and separately states the amount in Box 14. This increases the income reported by the shareholder. When the shareholder deducts the premiums as described below, it offsets the increased wages.
Partners
§707(c) provides that payments to partners for services or for use of capital that are determined without regard to partnership income are guaranteed payments. Payments by the partnership for health insurance fit this definition. Health insurance premiums for partners are reported on Schedule K-1, line 4. A statement should be included that indicates how much of the total on line 4 is for health insurance premiums.
It’s important to note that these guaranteed payments are subject to self-employment tax. The deduction for these premiums does not reduce self-employment income though which creates a disparity between partnerships and S-corporations in this area.
Sole Proprietors
This group reports their activity on Schedule C of Form 1040. They report self-employed health insurance premiums the same way as partners and S-corporation owners on their 1040 returns, as described below.
Form 1040 – Above-the-Line Deduction
For all three groups above, the actual deduction for self-employed health insurance is taken on page 1, line 29 of Form 1040 after any applicable limitations.
Hi – question that’s not really covered in this post…
Latest tax code states: “But if you were also eligible to participate in any subsidized health plan maintained by your or your spouse’s employer for any month or part of a month in 2015, amounts paid for health insurance coverage for that month can’t be used to figure the deduction.”
So, what is the IRS definition of “subsidized health plan” for form 1040 line 29 deduction? My wife is self employed and pays premiums out of pocket for herself and our kids. My employer subsidizes my individual insurance (so my individual coverage is cheap), and we have the option to cover my family with that same plan BUT that portion is NOT subsidized (and it’s very expensive so we don’t choose that option and instead buy insurance out of pocket for her and kids).
My interpretation is that even though she could be covered under my plan, it’s not at a subsidized rate for her/kids (even though my individual is), and that means we CAN claim her premiums in line 29.
Thoughts?
I just re-read the code section at §162(l)(2)(B) and it says no deduction is allowed for “any taxpayer for any calendar month for which the taxpayer is eligible to participate in any subsidized health plan maintained by any employer of the taxpayer or of the spouse of, or any dependent, or individual described in subparagraph (D) of paragraph (1) with respect to, the taxpayer.” I read the regulations and didn’t find any more elaboration on this rule. A technical interpretation would say that your health plan is subsidized because your premiums are subsidized. There’s no requirement that it be subsidized for all people on the plan. This means that your wife and children are eligible to participate in an employer subsidized plan.
I do see your point and think your argument has logical merit. I wish that there was more specific guidance for this situation.
Thanks and just saw your reply – appreciate the response. It’s odd that in what must be a very common situation like ours the language is not more clear. We used to be able to use a flexible spending account (FSA) to offset costs of non-employer sponsored health premiums, but that’s no longer allowed (I think 2013 was the last year for that). In my mind, the coverage that my employer makes available for my family is not subsidized – because my employer is small, the group/family rate is actually prohibitively expensive, so we elect not to use it and instead buy Blue Cross insurance “off the shelf”. We don’t qualify for any Obamacare discounts, so it’s the same price as “off the shelf” BCBS. Bascially, we pay a lot for health insurance for my family (and this year it increased 35%) and we don’t get any break on government plans, so all avenues for cost reduction have been removed for us, with the exception of claiming it on that Line 29. So, we’ll see what happens I guess. Thanks again.
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