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.
§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
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.
§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.
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.
§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.
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.