Can My S Corp Pay for My Health Insurance?
Understand how S Corps handle health insurance for owners, covering tax treatment, payment methods, and compliance requirements.
S Corporation owners face unique considerations regarding health insurance. Many small business owners operating as S Corps inquire about the deductibility of health insurance premiums paid on their behalf. The Internal Revenue Service (IRS) has specific rules for deducting these premiums, distinguishing between shareholder-employees and other employees. Understanding these regulations ensures compliance and maximizes potential tax benefits.
Defining the Shareholder-Employee Relationship
The treatment of health insurance premiums for S Corporation owners hinges on their classification as a “more than 2% shareholder.” A shareholder is considered a more than 2% shareholder if they own, directly or indirectly, more than 2% of the S Corporation’s outstanding stock or more than 2% of its total combined voting power on any day during the tax year. This includes stock owned by certain family members, such as a spouse, children, grandchildren, or parents.
The IRS treats more than 2% shareholders differently from other employees regarding fringe benefits, including health insurance. For tax purposes, these individuals are considered akin to partners in a partnership, rather than typical employees. Health insurance premiums paid by the S Corporation for these individuals are not treated as tax-free fringe benefits, as they would be for common-law employees. Instead, they are subject to specific reporting requirements.
Methods for S Corp Premium Payment
An S Corporation has two primary methods for handling health insurance premiums for its more than 2% shareholder-employees: direct payment to the insurance provider or reimbursement for premiums they have personally paid. Regardless of the method chosen, for the premiums to be deductible by the S Corporation and potentially by the shareholder, these amounts must be included in the shareholder-employee’s gross wages.
The inclusion of these premium amounts occurs in Box 1 (Wages, tips, other compensation) of the shareholder-employee’s Form W-2. While these amounts are added to Box 1, they are generally exempt from Social Security and Medicare (FICA) taxes and Federal Unemployment Tax Act (FUTA) taxes, provided the payments are made under a plan that covers all or a class of employees. The S Corporation effectively deducts these premiums as part of the shareholder-employee’s compensation expense on its tax return.
Individual Shareholder Tax Treatment
Once health insurance premiums are included in the shareholder-employee’s W-2 wages, the individual may be eligible to deduct these amounts on their personal tax return. This deduction is known as the “Self-Employed Health Insurance Deduction.” It allows more than 2% S Corporation shareholder-employees to reduce their adjusted gross income (AGI) by the amount of the premiums paid.
To qualify for this deduction, several conditions must be met. The health insurance plan must have been established by the S Corporation, meaning the S Corporation either paid the premiums directly or reimbursed the shareholder for premiums they paid. Furthermore, the shareholder must not have been eligible to participate in another employer-sponsored health plan, such as one offered by another employer or a spouse’s employer. This deduction is considered “above-the-line,” meaning it reduces taxable income regardless of whether the individual itemizes deductions or takes the standard deduction.
Reporting and Compliance
Accurate reporting of health insurance premiums for more than 2% S Corporation shareholder-employees is essential for compliance with IRS regulations. The health insurance premiums are reported in Box 1 (Wages, tips, other compensation) of the shareholder-employee’s Form W-2. These amounts are specifically excluded from Box 3 (Social Security wages) and Box 5 (Medicare wages) of the W-2, as they are not subject to FICA taxes. Many S Corporations also choose to report the amount of health insurance premiums in Box 14 (Other) of the W-2 for informational purposes, labeling it as “2% SH Health Ins.” or similar.
On the individual’s tax return, the Self-Employed Health Insurance Deduction is claimed on Schedule 1 (Form 1040), specifically on Line 17. This directly reduces the individual’s adjusted gross income. For the S Corporation, the premiums are effectively deducted as part of the total compensation paid to the shareholder-employee, which is reported on the S Corporation’s tax return, Form 1120-S. There isn’t a separate line item for health insurance on Form 1120-S; instead, it is included within the overall wage expense.