Can an S Corp Deduct Health Insurance Premiums for an Owner?

An S corporation can offer distinct tax advantages for business owners, particularly concerning self-employment taxes. However, the treatment of health insurance premiums for owners in an S corporation structure involves specific IRS rules. Understanding these rules helps S corporation owners optimize their tax situation and account for health insurance. While direct tax-free health insurance benefits are not available to owners in the same way they are for regular employees, a specific deduction mechanism exists.

Conditions for Deducting Premiums

For an S corporation owner to deduct health insurance premiums, eligibility criteria apply. A primary condition involves the “more than 2% shareholder” rule. This rule applies to any individual who owns, either directly or indirectly through family attribution rules (such as a spouse, children, grandchildren, or parents), more than 2% of the S corporation’s outstanding stock or stock possessing more than 2% of the total combined voting power of all stock.

The health insurance plan itself must be established by the S corporation. This means the S corporation must either directly pay the premiums to the insurance provider or reimburse the owner for premiums they personally paid. If the owner pays premiums without reimbursement from the S corporation, the deduction is not permitted.

Another condition is that the S corporation owner cannot be eligible to participate in another employer-sponsored health plan for the months the deduction is claimed. This includes eligibility through a spouse’s employer. The eligibility for other coverage is determined on a month-by-month basis.

The S corporation owner must also be a bona fide employee of the S corporation. This ensures the health insurance premiums are properly considered as a form of compensation.

How S Corporations Handle Premium Payments

When an S corporation pays health insurance premiums for a more-than-2% shareholder, these payments are treated as additional wages for income tax purposes. The S corporation must include the amount of these premiums in Box 1 (Wages, Tips, Other Compensation) of the owner’s Form W-2. This reporting is essential for the owner to claim the deduction on their personal tax return.

While these premiums are included in Box 1 for federal income tax withholding, they are not subject to Social Security and Medicare (FICA) taxes. This distinction is important for payroll tax calculations. The premiums may also be reported in Box 14 of the W-2 for informational purposes.

The S corporation itself can deduct these premium payments as an ordinary and necessary business expense on its tax return, Form 1120-S. The deduction is recorded as compensation of officers or salaries and wages. This allows the corporation to reduce its taxable income, reflecting the cost of providing the benefit.

The inclusion of health insurance premiums in the owner’s W-2 wages is an IRS requirement that facilitates the owner’s personal tax deduction. If the S corporation does not report these amounts correctly, it could jeopardize the corporation’s ability to deduct the expense and the owner’s ability to claim the personal deduction.

Owner’s Personal Deduction Process

An S corporation owner, having met the eligibility conditions and received proper W-2 reporting, claims the health insurance deduction on their personal income tax return. This “above-the-line” adjustment reduces the owner’s adjusted gross income (AGI) regardless of whether they itemize deductions. This advantage can lower overall taxable income.

The deduction is known as the self-employed health insurance deduction. It is reported on Schedule 1 of Form 1040, on Line 17. For tax years starting in 2023, the calculation of this deduction is made using Form 7206, Self-Employed Health Insurance Deduction, which replaced a worksheet previously found in IRS Publication 535.

A limitation on this deduction is that it cannot exceed the owner’s earned income from the S corporation. For this purpose, earned income refers to the wages reported on their W-2 from the S corporation. If an owner has multiple S corporations, the deduction is limited by the total earned income from all such entities.

Only qualified health insurance premiums can be deducted, which include medical, dental, and qualifying long-term care insurance. Premiums paid for the owner, their spouse, dependents, and non-dependent children under age 27 can be included. This deduction allows S corporation owners to effectively reduce their personal tax liability for health insurance costs incurred through their business.