Article: Deducting S Corporation Health Insurance Payments


	Jeff Bither

December 2008

Deducting S Corporation Health Insurance Payments

Qualifying for a valuable income tax deduction requires the S corporation to make payments or reimbursements before year-end, and include them in the shareholder-employee’s W-2

Caution! New! IRS Notice 2008-1 specifically requires health insurance premiums to be included in the shareholder-employee’s Form W-2 for the year the premiums are paid in order for the shareholder to deduct the premiums as a for-AGI deduction. If you are a more-than-2% shareholder of an S corporation, please communicate immediately with your payroll department or payroll service provider to ensure appropriate W-2 inclusion for 2008.

In our March 2008 Bottom Line article (“Health Benefits: Good News for Small Business Owners”), we wrote about a change in IRS policy that expands the deductibility of health care coverage for S corporation shareholder-employees. That change, set forth in IRS Notice 2008-1, provides that an S corporation may pay the health insurance premium directly to the insurance company, or the S corporation may reimburse the shareholder-employee for the premium that he or she pays personally.

This flexibility is a significant departure from the IRS’s historic position that a health insurance policy for an S corporation shareholder-employee must be owned by the S corporation. Prior to issuing Notice 2008-1, the IRS had asserted that the S corporation could not deduct the reimbursement of premium costs if the policy was owned by the shareholder-employee.

Now, policy ownership is not a factor. Notice 2008-1 allows a shareholder-employee to deduct medical insurance premiums as an “above the line” deduction even if the policy is in the shareholder-employee’s name.

How to Obtain the Deduction

With the end of the year approaching, S corporations should be mindful that, to obtain the deduction, they must meet these requirements:

the S corporation must include the premium payment in the shareholder-employee’s W-2 for that tax year;
the shareholder-employee must report the premium payments or reimbursements from the S corporation as gross income on his or her Form 1040; and
if the shareholder-employee paid their health premiums directly to the insurance company, the S corporation must reimburse the shareholder-employee during the same tax year, after receiving proof of the shareholder-employee’s premium payments.

The following examples assume that (a) each shareholder is a 2% shareholder-employee in an S corporation, (b) his/her earned income from the S corporation exceeds the amount of the health insurance premiums, and (c) none of the shareholders in the following examples is eligible to participate in any subsidized health plan maintained by an employer of the shareholder or the shareholder’s spouse.

Example 1. Shareholder-employee Smith owns a health insurance policy. His S corporation makes all of the premium payments to the insurance company. The S corporation reports the amount of the premiums as wages on Smith’s Form W-2 for 2008 (thus qualifying for the deduction), and Smith reports that amount as gross income on his Form 1040 for 2008.

Example 2. Shareholder-employee Jones owns a health insurance policy. Jones makes the premium payments to the insurance company and, before year-end, submits to her S corporation proof of her premium payments. Also before year-end, the S corporation reimburses Jones for her premium payments. The S corporation reports the amount of the premiums as wages on Jones’s Form W-2 for 2008 (thus qualifying for the deduction), and Jones reports that amount as gross income on her Form 1040 for 2008.

Amended Returns for Prior Years

Taxpayers who did not claim deductions for fringe benefits described in Notice 2008-1 may file timely amended tax returns to claim the deduction, provided the taxpayers satisfy the Notice’s requirements. The statement “Filed Pursuant to Notice 2008-1” should be written on the top of any amended return.

If you have any questions about whether your S corporation’s health insurance payment or reimbursement procedures are sufficient to qualify for an income tax deduction, please contact your Schmidt Westergard & Company tax professional.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.