Choosing an S-corporation to form your business comes with several impressive tax advantages. You don’t pay corporate income tax, and your social security and Medicare taxes are lower. Profits are allocated to shareholders and taxed at that point.
However, an S-corporation’s health insurance can be a tricky matter. While S-corp employees can claim employee health insurance as a tax-free benefit, shareholders who own more than 2% of the company stock don’t get this same perk. For these individuals, S-corp health insurance deduction is more complicated.
This article will go over everything S-corp owners must do to receive company-sponsored health insurance, how to deduct those expenses from their taxes properly, and how flexible health benefits affect their eligibility.
As an owner, can my S-corp pay my health insurance?
Most people assume all businesses can provide health insurance to their employees, including owners, tax-free. While this is true for C-corporations, it isn’t the case for S-corps.
S-corporations can provide health insurance as a tax-free benefit to their non-owner employees. This means the company offers group health insurance to employees and deducts the cost as a business expense, paying no taxes on the insurance premiums. However, health insurance for S-corp owners isn’t quite so easy.
Shareholders owning greater than 2% of stock must include their health insurance costs paid through the company as income, according to Internal Revenue Code Section 707(c), making the amount subject to income tax.
However, the amount is free from Medicare, unemployment, and social security taxes if the payments are made on behalf of an employee under a plan that provides for all employees or a class of employees.
Unlike owners of an LLC or partnership, S-corp owners can’t get around this rule by employing their spouse and getting coverage through their participation in the health plan. For health insurance purposes, spouses and other family members of an S-corp owner are considered an S-corp owner themselves, even if the family members don’t have any stock in their names.
Can an S-corp owner deduct health insurance?
While S-corp owners may not have the same access to tax-free health insurance as their employees, they’re still able to receive tax-advantaged premiums. This can be done by taking a personal income tax deduction on the health insurance premiums paid by the company.
For S-corp owners to qualify for the deduction, their health insurance policy must be established by the company and not by the S-corp owner personally.
To determine whether the policy is established by the business, the IRS considers:
- Who pays policy premiums
- How the premiums are reported for income tax purposes by both the company and the S-corp owner
To qualify, the company must pay the S-corp owner’s insurance premium, including the premiums as gross wages in the S-corp owner’s W-2. The company must either pay for the premiums directly or by reimbursing the S-corp owner.
If the S-corp owner pays the policy premiums on their own, without a reimbursement by the business, this does not qualify the owner for a tax deduction. If the owner does qualify, S-corp deduction can be made with Form 1040.
Under this method, S-corp owners can deduct premiums for accident, dental, and long-term care policies as well as for health insurance policies.
How do health reimbursement arrangements (HRAs) affect S-corp owners?
Many S-corp owners want to know how these rules affect their eligibility to participate in a health reimbursement arrangement (HRA).
Because HRAs are only eligible for W-2 employees, and S-corp owners are taxed as shareholders, S-corp owners and their families aren’t considered employees and therefore aren’t allowed to participate in an HRA.
Some S-corp owners want to participate in an HRA solely to track their expenses, but this isn’t permitted either. HRAs function as a reimbursement benefit, and when insurance policy premiums are reimbursed, they aren’t considered to be “established by the business.” This means S-corp owners and their families wouldn’t be able to deduct those expenses even if they participated in the HRA for tracking purposes.
However, S-corp owners can still offer an HRA to non-owner employees. HRAs allow the S-corporation to have complete control over their budget while giving employees the freedom to choose how they spend their healthcare allowance.
How do fringe benefits affect S-corp owners?
Employee stipends, or taxable fringe benefits, are a popular benefits option for businesses of all sizes. If you’re an S-corp owner interested in offering a health stipend because of their more relaxed rules, you might be wondering if you can participate.
As an S-corp, you can offer taxable health fringe benefits to your employees as taxable income, just like any other type of business. As an S-corp owner, you can also participate in your taxable health stipend benefit as long as you include it as income.
Health stipends for S-corp shareholders are subject to FICA, FUTA, FITW, and SITW. Taxable fringe benefits may be deductible as salaries and wages on Form 1120S, but they must be reported as income to do so.
S-corp owners' health insurance doesn’t function as a tax-free fringe benefit the same way C-corp owners’ does. However, they can still have access to tax-advantaged health insurance through the company.
If S-corp owners ensure their policy is established through their business, they can deduct any payments made toward the premiums on their Form 1040 when they file taxes at the end of the year.
In the meantime, they can offer their employees a quality health insurance benefit with a traditional group policy, health stipend, or an HRA. This way, everyone in the S-corporation will have access to health insurance through the company with complete coverage.
If you’re interested in offering an HRA or employee stipend to your employees, PeopleKeep can help!
This blog article was originally published on May 14, 2019. It was last updated on May 31, 2022.