Overview
Selecting an S Corporation as your business structure offers various tax benefits, including the potential to reduce self-employment taxes for shareholders. However, many shareholders of S Corporations are often taken aback by how employer-provided health insurance premiums are handled.
Health Insurance for S Corporation Shareholder
Many private practice owners believe that health insurance provided to employees, including owners, is tax-free. However, if the company offers medical coverage to shareholders owning 2% or more of the stock, the premiums are treated as taxable income for those shareholders.
According to the IRS, a 2% shareholder is defined as someone who owns, directly or indirectly, more than 2% of the outstanding stock of the S Corporation or more than 2% of the total combined voting power of all stock at any point during the tax year.
S Corporation shareholders cannot bypass this rule by employing their spouse and obtaining coverage through the spouse’s participation in the company-sponsored health plan.
Treating medical insurance the correct way
The S corporation and shareholder can still receive tax benefits for these health insurance premiums if they follow the correct process. Health insurance premiums can be deducted from your gross income to calculate your adjusted gross income as an above-the-line deduction.
Following the correct process would allow the S corporation to receive the deduction and the shareholder to reduce the premiums by claiming an above-the-line deduction.
Tax treatment by the company
The company can deduct premium payments for 2% shareholders on its Form 1120S income tax return. Since the premiums are classified as additional wages for the shareholder, the deduction is recorded under Compensation of Officers on page 1. This deduction reduces the net income (or increases the net loss) that flows through to shareholders on their Schedule K-1.
Tax treatment by the 2% shareholder
Health insurance premiums are included in Box 1 of the shareholder's W-2, making them subject to income tax. However, shareholders do not have to pay Social Security, Medicare, or unemployment (FUTA) taxes on these premiums.
Please note: When you receive your W-2, the amount of your health insurance premiums will be included in box 14.
Shareholders can deduct 100% of the premiums paid by the company as a self-employed health insurance deduction. This is an above-the-line deduction on the shareholder's personal tax return, Form 1040, so itemizing is not required to take advantage of it.
S Corporation owners can also use this method to deduct premiums for accident, dental, vision, and long-term care insurance coverage. Your Tax Preparer will prepare these deductions if you are filing with Heard.
Conclusion
The bottom line is that in order for a shareholder to claim an above-the-line deduction, the health insurance premiums must ultimately be paid by the S corporation and must be reported as taxable compensation in the shareholder's W-2.
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