This article explains the tax impact of health insurance premiums paid on behalf of greater than 2% shareholder/employees in an S corporation.
*Please note that this information does not apply to shareholder employees who own 2% or less of the outstanding S Corporation stock.
Greater than 2% S corporation shareholder/employees can deduct health insurance premiums paid by an S corporation on page one of their individual income tax return and the health insurance premiums paid on their behalf are not deductible on the S Corporation tax return as such but must be included in the compensation section of the corporate tax return and reported as wages to the greater than 2% S corporation shareholder/employee.
“Health insurance” includes premiums paid for health, dental, vision, long-term care and HSA contributions made by the corporation on behalf of the greater than 2% shareholder (and any payments made on behalf of related parties e.g. spouse and children of the greater than 2% shareholder).
To qualify for deduction, the S corporation must report the insurance premiums paid or reimbursed on the greater than 2% shareholder/employee’s Form W-2, and the employee must report the payments or reimbursements as gross income on their individual income tax return. The employee will also get a deduction on their individual tax return for the health insurance premiums paid on his or her behalf. The net effect of this rule is that the greater than 2% shareholder/employee receives the health insurance benefit free of income tax.
This is most definitely a form over substance requirement and failure to follow the technical rules will result in the greater than 2% shareholder/employee being taxed on the premiums paid for his or her health insurance.
Eligible health insurance for an S corporation can either be through a plan in the S corporations name or through an individual plan held by the shareholder, as long as premiums for the individual plan are either paid directly to the insurance company through the S corporation or if the premiums are paid by the shareholder, the S corporation must reimburse the shareholder. (Thus, in effect, the health insurance policy is being adopted by the S corporation). If payments are paid on a personal policy directly by the shareholder and not reimbursed to the shareholder by the S corporation and included as wages in their annual W-2, the payments are NOT eligible for deduction on Form 1040 Individual Income Tax Return as Self-Employed Health Insurance Premiums.
Generally, the “health insurance” payments are included on the W-2 as gross wages for income tax withholding purposes only and are NOT wages subject to Social Security, Medicare taxes or Federal Unemployment Wages. (Note – greater than 2% S corporation shareholders are NOT eligible for Section 125 plans thus these “health insurance” payments do not qualify for exclusion from taxable wages.) If you have an individual policy and not a corporate group policy any reimbursements made by the corporation to an employee are subject to Social Security, Medicare taxes and FUTA as a result of the recently enacted Affordable Care Act.
If you are using a payroll company to prepare your payroll, we recommend you contact them in December before the last payroll of the year is prepared and before year-end reports are prepared and notify them that you qualify as a greater than 2% or more shareholder and are not eligible under Section 125 to exclude health insurance/fringe benefits from taxable income. Please provide them with information regarding health insurance premiums paid on your behalf by the S corporation to ensure correct treatment. If the payroll company does not have shareholder health insurance to properly report on Form W-2 and other required reports, corrected reports will be required resulting in additional costs and delays to you.
If you prepare your own payroll or if you have any other questions please contact us for specific instructions.