Health Insurance Premiums: Tax implication for the self employed – example
A tax payer is the 100% owner/employee of an S corporation that she started in 2010. She only wants to take $2,000 in wages for the first year. In addition, she would like the S corporation to pay for her health insurance, which costs about $4,800 per year. Her friend told her that if the S corporation pays the premiums, she will have to include this amount as wages on Form W-2. However, she can claim a self-employed health insurance deduction for the same amount on her Form 1040, which will zero out such income. What advice would you give to Heidi?
Answer: First, an S corporation shareholder/employee must take reasonable compensation for services performed for the corporation. Otherwise, the IRS can recharacterize distributions, loans, or similar payments to the shareholder as wages. Reasonable compensation is based on the facts and circumstances. Second, health insurance premiums paid on behalf of a more-than-2% S corporation shareholder/employee are additional compensation in box 1 of Form W-2 [Rev. Rul. 91-26]. However, they are not subject to FICA or FUTA [Ann. 92-16]. In addition, the shareholder can deduct the health insurance premiums as self-employed health insurance provided they do not exceed the earned income limit on the deduction. For this purpose, the shareholder’s FICA wages from the S corporation are treated as earned income [§162(l)(5)(A)]. According to the Form 1040 instructions for the self-employed health insurance deduction, earned income is the shareholder’s Medicare wages. Thus, Heidi can only deduct $2,000 (not the full $4,800) of the premiums as self-employed health insurance because her FICA and Medicare wages are only $2,000. Heidi can deduct the balance of the premiums ($2,800) on Schedule A (Form 1040), subject to the 7.5% of AGI limitation. Heidi may want to consider increasing the amount she takes in wages for 2010.
John R. Dundon, EA - 720-234-1177