Napier & Company, LCC

A self-employed individual can deduct as a business expense 100% of the amount paid during the tax year for medical insurance on him/herself, spouse, and dependents. The IRS concludes that a self-employed individual who is a sole-proprietor and who purchases health insurance in his own name can treat the health insurance as purchased in the name of his business. As such, the self-employed individual can claim an above-the-line deduction for the insurance premiums. 

In contrast to a sole proprietorship, if the business is operating as an S corporation, a different tax consequence applies for a sole shareholder-employee who purchases health insurance in his own name.

Health Insurance Bought by S Corporation:

For certain fringe benefits, including health insurance premiums, an S corporation is treated as a partnership, and any shareholder who owns for than 2% of the S corporation’s stock is treated as a partner. Accident and health insurance premiums paid by a partnership on behalf of a partner are guaranteed payments if the premiums are paid for services rendered in the capacity of a partner and to the extent the premiums are determined without regard to partnership income. As guaranteed payments, the premiums are deductible by the partnership and includible in the partner’s gross income. 

While health insurance premiums paid by an S corporation aren’t deductible by the S corporation as a fringe benefit, they are deductible by it as compensation to the 2% shareholder. The health insurance premiums paid by the S corporation for the 2% shareholder is included in his W-2. The amounts are not subject to FICA or employer payroll taxes, but would only show up in box one of taxable wages. A 2% shareholder who is considered a partner is treated as a self-employed person and, assuming all other requirements are met, can deduct the health insurance premiums paid by the S corporation as an above-the-line deduction. 

Health Insurance Bought by S Shareholder:

A problem arises if the sole shareholder-employee buys health insurance in his own name instead of the S corporation’s. Because the S corporation has not established a plan to provide medical care coverage, IRS reasons that there is no fringe benefit paid to the 2% shareholder. As a result, the S corporation is not treated as a partnership, and the shareholder is not treated as a partner. The shareholder is not considered self-employed and isn’t eligible for the above-the-line deduction. However, the shareholder is still able to deduct the health insurance as an itemized deduction, subject to the 7.5% adjusted gross income limit for medical expenses.