Can S Corp Shareholders Deduct Medicare Premiums?
For S corp shareholders, deducting Medicare premiums depends on a specific reporting method involving the company's W-2 and a personal tax return.
S corporation shareholders can deduct Medicare premiums, but this tax benefit is contingent on following a specific set of rules established by the IRS. The process requires careful coordination between the corporation and the shareholder’s personal tax return. This treatment applies specifically to individuals who are considered more-than-2% shareholder-employees, a status defined as owning over 2% of the company’s outstanding stock or voting power while also receiving a salary for services rendered.
Eligibility Requirements for the Deduction
The ability to deduct Medicare premiums is reserved for shareholder-employees who own more than 2% of the S corporation’s stock. Individuals owning 2% or less are treated as regular employees for fringe benefit purposes. A requirement for the deduction is that the S corporation must establish a health insurance plan for the shareholder-employee. The IRS considers a plan “established” if the corporation either pays the Medicare premiums directly on behalf of the shareholder or reimburses the shareholder for premiums they paid personally. This policy can be formalized through a corporate resolution or other internal document.
A limitation on this deduction is the shareholder’s access to other subsidized health plans. The shareholder-employee is ineligible for this deduction if they, or their spouse, could participate in another employer’s health plan. This rule, found in Internal Revenue Code § 162, prevents individuals from opting out of an available subsidized plan to take the self-employed health insurance deduction instead.
The Correct Reporting Procedure
The S corporation has a two-part responsibility to ensure the shareholder can claim the deduction. First, the corporation must pay for the Medicare premiums, either by sending payments directly to the provider or by reimbursing the shareholder for the expense. The corporation then deducts these payments on its own tax return, Form 1120-S, as part of officer compensation.
The second step for the corporation is to report the premium amount as income to the shareholder-employee. The total value of the Medicare premiums paid or reimbursed must be included in the shareholder’s wages in Box 1 of their Form W-2. However, these specific premium amounts are exempt from FICA taxes (Social Security and Medicare) and FUTA (federal unemployment) taxes, so they are not included in Box 3 or Box 5 of the W-2.
Once the shareholder-employee receives their W-2 with the premiums included in Box 1, they can take the deduction on their personal tax return. On Form 1040, the shareholder reports the full wage amount from their W-2 as income. They then claim the Self-Employed Health Insurance Deduction on Schedule 1 of Form 1040. This “above-the-line” deduction directly reduces their Adjusted Gross Income (AGI), effectively canceling out the income inclusion from the W-2 and resulting in a net zero tax effect on that amount.
Key Nuances and Limitations
According to IRS Notice 2008-1, a deduction is still possible even if the shareholder pays for their Medicare premiums directly from a personal bank account and is not reimbursed. For this to be valid, the shareholder must provide proof of the premium payments to the S corporation. The corporation must then include that premium amount in the shareholder’s W-2 wages, just as if it had reimbursed them. The deduction is not limited to just the shareholder’s own Medicare premiums and can be extended to cover premiums paid for a spouse, dependents, and children under the age of 27.
A limitation is that the self-employed health insurance deduction cannot exceed the shareholder’s wages from the S corporation for that tax year. For example, if a shareholder receives a salary of $5,000 and has $6,000 in Medicare premiums, their deduction is capped at $5,000. The deduction cannot be used to create a loss from wages on the personal tax return. The shareholder must have earned enough in W-2 wages from the S corporation to cover the amount of the premium deduction.