Small Business Employee Benefits and HR Blog

How S-corporation owners can deduct health insurance expenses

May 14, 2019
How S-corporation owners can deduct health insurance expenses

Choosing an S-corporation to form your business comes with a number of impressive tax advantages. You don’t pay corporate income tax, and your Social Security and Medicare tax bills are lower—instead, profits are allocated to shareholders and taxed at that level.

Things get more complicated when it comes to health insurance, though. While S-corporation employees can claim employee health insurance as a tax-free benefit, shareholders who own more than 2 percent of the company stock cannot. For these individuals, the path to tax-advantaged health insurance is more complicated.

In this post, we’ll examine everything S-corp owners must do to receive company-sponsored health insurance and properly deduct those expenses from their tax bill.

S-corp owners can’t receive health insurance as a tax-free fringe benefit

Most people assume all businesses can provide health insurance to their employees and owners on a tax-free basis. While this is true for C-corporations, it isn’t the case with an S-corporation.

S-corporations can provide health insurance as a tax-free fringe benefit to its non-owner employees. In this case, the business offers a group health insurance policy to employees and deducts the cost as a business expense, paying no tax on the insurance premiums.

Greater than 2 percent shareholders, however, must include the cost of their health insurance as income, according to Section 707(c) of the Internal Revenue Code. This means the amount S-corp owners pay for their health insurance is subject to income tax, as well as Social Security and Medicare tax.

And unlike owners of an LLC or a partnership, S-corp owners can’t get around this rule by employing their spouse and getting covered through their participation in the plan. For health insurance purposes, spouses and other family members of an S-corp owner are treated as though they were an S-corp owner themselves. This is true even if the family members don’t have any stock in their names.

Personal income tax deduction for health insurance premiums

S-corp owners may not have the same access to tax-free health insurance as non-owner employees, but they can still ensure their premiums are tax-advantaged. Specifically, S-corp owners can take a personal income tax deduction on the health insurance premiums paid by the business.

For S-corp owners to qualify for the deduction, their health insurance policy must be established by the business and not by the S-corp owner personally.

To determine whether the policy is established by the business, the IRS considers:

 

  • Who pays the premiums for the policy, and
  • How the premiums are reported for income tax purposes by both the business and the S-corp owner.

The business must pay the S-corp owner’s premiums directly. It must also include the premiums as gross wages in the S-corp owner’s Form W-2. If the S-corp owner pays the policy premiums on their own and then gets reimbursed by the business, this does not qualify the owner for a tax deduction.

If the S-corp owner does qualify, they can deduct their premiums on Form 1040, line 29.

S-corp owners can use this method to deduct premiums for accident, dental, and long-term care policies as well as for health insurance policies.

What does this mean for S-corp owners and HRAs?

Many S-corp owners want to know how these rules factor into their eligibility to participate in a health reimbursement arrangement (HRA).

Because HRAs are only available to W-2 employeesand S-corp owners are taxed as shareholders representing the company’s profitsS-corp owners and their families aren’t employees and therefore aren’t eligible to participate in the benefit.

Some S-corp owners want to participate in an HRA solely to track their expenses, but this too is a dead end. HRAs function on a reimbursement basis, and when insurance policy premiums are reimbursed, they aren’t considered “established by the business.” This would mean S-corp owners and their families would lose their ability to deduct those expenses even if they could participate in the HRA for tracking purposes.

S-corp owners can still offer an HRA to non-owner employees, though. HRAs allow the S-corp to have complete control over their health benefits budget while giving employees freedom of choice in how they spend their health care dollars.

To learn more about the benefits of an HRA and other eligibility requirements, check out PeopleKeep’s HRA education page.

Conclusion

S-corp owners can’t receive health insurance as a tax-free fringe benefit the same way C-corp owners can. 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.

In the meantime, they can offer their employees a quality health insurance benefit with a group policy or an HRA. This way, everyone has access to tax-advantaged health insurance through the company.

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