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Go ahead: Deduct health insurance paid by your S corporation

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in Employee Benefits Program,Human Resources

Does your S corporation directly pay for or reimburse you for your health insurance premiums? In 2006, the IRS indicated on its web site that you can’t deduct such costs “above-the-line” if the health insurance is purchased in your own name.

Strategy: Claim above-the-line deductions for ’07. A new IRS Notice gives certain S corporation owners official approval. (IRS Notice 2008-1)

The whole story: For fringe benefits, the IRS treats a 2%-or-more shareholder of an S corporation like a partner in a partnership. So corporate health insurance premium payments aren’t tax-free to you, like they are to other employees. Report the payments as taxable income.

A tax-law provision allows a self-employed individual who is not treated as an employee to deduct health insurance—including amounts paid for dependents—up to the amount of his or her earned income from the business. (IRC Sec. 162(l)) The above-the-line deduction isn’t available if the self-employed person is eligible to participate in a subsidized health insurance plan of his or her employer or the spouse’s employer.

As a 2%-or-more S corporation shareholder, the IRS previously said that you’re eligible for this tax break only if the health insurance plan is established by the S corporation and the insurance is taken out in the S corporation’s name. Now the IRS has eased the rules. An S corporation will be treated as having established the plan if:

  • The S corporation pays the premiums for the policy in the current taxable year; or
  • The shareholder pays the premiums, provides proof of payment to the S corporation and the S corporation reimburses the shareholder in the current taxable year.

It doesn’t matter if the policy is in the name of the corporation or the shareholder.

The S corporation must report the cost of the premiums paid or reimbursed as wages to the shareholder on Form W-2. Those amounts must be included in the shareholder’s income.

The IRS gives four examples in the new Notice:

Example 1: A 2%-or-more shareholder obtains a health insurance policy in his or her name and pays the premiums. The S corporation neither makes payments nor reimburses the shareholder for the premiums. The S corporation has not established the health plan, so the shareholder isn’t entitled to the above-the-line deduction.

Example 2: The S corporation obtains a health insurance policy in its own name. The plan covers the 2%-or-more shareholder, the shareholder’s spouse and dependents. The corporation pays the premiums and reports them as wages to the shareholder. The shareholder reports the amounts as income. The S corporation has established a health insurance plan for the shareholder, so he or she can take the above-the-line deduction.

Example 3: The shareholder obtains a health insurance policy in his or her own name. The S corporation pays all the premiums, and the shareholder reports the premium amount as income. The S corporation has established a health plan for the shareholder, who may take the above-the-line deduction.

Example 4: The shareholder obtains a health insurance policy in his or her own name and makes the premium payments. The shareholder furnishes proof of payment to the S corporation, which reimburses the shareholder. The corporation has established a health plan for the shareholder, who can take the above-the-line deduction.

Tip: When it applies, consider amending your returns for the prior tax years.

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