How Rev. Rul. 96-7 Affects S Corp Health Insurance

Revenue Ruling 96-7 provides guidance for S corporations paying for shareholder health insurance. This ruling from the Internal Revenue Service (IRS) clarifies the tax treatment for accident and health insurance premiums that an S corporation pays for shareholders who own more than two percent of the company. The ruling establishes a multi-step process for deducting the premium costs and reporting them as income, affecting both corporate and personal tax returns.

Tax Treatment for the S Corporation and Shareholder

For the tax treatment to apply, the individual must be a “2-percent shareholder,” defined as any person who owns more than two percent of the corporation’s stock on any day of the tax year. The ownership attribution rules also apply, meaning an individual is considered to own the stock owned by their spouse, children, grandchildren, and parents.

While the S corporation receives a deduction for the premium costs, the 2-percent shareholder-employee must include the total amount of the premiums paid on their behalf in their gross income. This amount is reported as wages on the shareholder’s Form W-2. The premium value is subject to federal income tax withholding but is exempt from FICA (Social Security and Medicare) and FUTA (Federal Unemployment Tax Act) taxes.

For fringe benefit purposes, a 2-percent shareholder is treated similarly to a partner in a partnership, not as a typical employee. Regular employees can receive health insurance benefits as a tax-free fringe benefit, but this exclusion does not extend to 2-percent S corporation shareholders. The ruling provides a mechanism that aligns their treatment with that of self-employed individuals.

The Shareholder’s Self-Employed Health Insurance Deduction

After the shareholder includes the health insurance premiums in their gross income, they may be able to deduct the cost on their personal tax return. This is done through the self-employed health insurance deduction. This deduction is taken “above-the-line” when calculating Adjusted Gross Income (AGI) on Form 1040, which means the shareholder does not need to itemize deductions to receive this tax benefit.

The amount of the deduction is limited and cannot exceed the shareholder’s pro-rata share of the S corporation’s net earnings. The shareholder must also have an adequate basis in their stock or debt from the S corporation to claim the deduction. This rule ensures that the deduction is backed by actual business income earned by the shareholder.

A shareholder is ineligible for the self-employed health insurance deduction for any month they were eligible to participate in a subsidized health plan offered by another employer. This includes eligibility through a spouse’s employer-sponsored plan. If a shareholder’s spouse has a family health plan available at their job, the shareholder cannot claim the deduction, even if they decline to participate in the spouse’s plan.

The deduction can also cover payments for dental insurance and qualified long-term care (LTC) insurance. For qualified LTC insurance, the deductible portion of the premiums is subject to annual, age-based limits. For 2025, those limits are:

• $480 for individuals 40 and under
• $900 for ages 41 to 50
• $1,800 for ages 51 to 60
• $4,810 for ages 61 to 70
• $6,020 for those over 70

Requirements for Establishing a Plan

To qualify for the tax treatment outlined in Revenue Ruling 96-7, the health insurance plan must be “established by the S corporation.” The business must formally adopt the plan, which is accomplished through a written document, such as a corporate resolution recorded in the company’s minutes or a formal plan document.

There are two primary methods for an S corporation to make premium payments under an established plan. The S corporation can pay the insurance provider directly on behalf of the shareholder-employee. Alternatively, the corporation can reimburse the shareholder for premiums they paid personally, provided a formal reimbursement arrangement is in place.

Following the Affordable Care Act (ACA), certain employer reimbursement plans can violate market reforms. To provide a compliant path for small employers, arrangements like the Qualified Small Employer Health Reimbursement Arrangement (QSEHRA) were created. However, 2-percent S corporation shareholder-employees are not eligible to participate in a QSEHRA, making the W-2 inclusion method the prescribed path for their own benefit.

If the shareholder pays for the health insurance premiums personally and is not formally reimbursed by the S corporation under a qualifying plan, the tax treatment is lost. In that scenario, the S corporation cannot deduct the premium cost, and the shareholder cannot claim the self-employed health insurance deduction.

Tax Reporting Procedures

The reporting process involves actions on both the corporation’s and the shareholder’s tax filings. For the S corporation, the health insurance premiums paid for a 2-percent shareholder are deducted as a business expense. This amount is included in the total figure reported on the line for “Officers’ Compensation” on Form 1120-S.

On the shareholder’s side, the S corporation must report the premium payments on Form W-2. The total amount of the premiums is included in the taxable wages reported in Box 1, “Wages, tips, other compensation.” This amount is excluded from the wages reported in Box 3, “Social Security wages,” and Box 5, “Medicare wages,” as these payments are not subject to FICA taxes. It is also a best practice to identify the amount of the health insurance premiums in Box 14, “Other.”

Finally, the shareholder-employee claims their deduction on their personal income tax return. The self-employed health insurance deduction is taken on Schedule 1 (Form 1040), Additional Income and Adjustments to Income. This places the deduction in the “Adjustments to Income” section, allowing it to be subtracted from gross income to arrive at adjusted gross income.