For the majority of business formations, the IRS has provisions that allow the business owner to acquire health insurance in their own name and treat that health insurance as a business expense (Internal Revenue Code 162). But what if the business is operating as an S-Corporation? There is a different tax consequence if the individual is the sole shareholder and sole employee and purchases health insurance in their own name.
According to Internal Revenue Code 1372(a) an S-Corp that pays for health insurance and other fringe benefits for an owner who owns more than 2% of the corporation’s stock (2% shareholder) will be treated as a partnership. Now that the S-Corp is considered a partnership, the rules can get a little tricky. In a partnership health insurance is consider a guaranteed payment (IRC 707(c)) and those payments are deductible and included in the partner’s gross income.
With an S-Corp however, insurance paid by the S-Corp would NOT be deductible by the S-Corporation as a fringe benefit but would be deductible by the S-Corp as compensation to the 2% shareholder. The insurance amounts would be included on the shareholder’s W-2. Certain conditions must be met by the S-Corp for this deduction to be allowed. If the shareholder is eligible to participate in any other health plan whether from another employer and/or spouse’s employer, the deduction is not allowed.
With that said, the S-Corp would have to purchase the health insurance for any deductions to be allowed. But what if the shareholder purchases a health plan in their own name? Since some states do not allow corporations to purchase group health plans with only one participant, many S-Corp owners must purchase health plans on their own. If this occurs, everything stated above does not apply to the situation. The shareholder however, is still able to deduct the health insurance as an itemized deduction which will be subject to the 7.5% AGI (adjusted gross income) limitation.
Next time we will look at additional strategies for S-Corp owners to use to provide themselves with health insurance in particular Health Reimbursement Arrangements (HRA). Until next time keep your Business N Synergy.
Brian N. Stovall