Question or Topic 

What are the tax rules for tax deductions of Health Insurance Premiums paid by an S Corporation - or Paid by and individual shareholder than is more than a 2% shareholder?

The Answer

HEALTH INSURANCE PREMIUMS

Contributions by an employer to an accident and health plan are not included in the income of the employee. Code Section 106(a). Thus, payments of health insurance premiums by an S corporation on behalf of an employee who is not a 2 percent shareholder are excluded from the income of the employee. However, the IRS has ruled that with respect to health insurance premiums paid by an S corporation on behalf of an employee who is a 2 percent shareholder, the exclusion does not apply, and the value of the payments must be included in the income of the employee - shown on the W2; such payments are not wages for FICA (social security and Medicare) tax purposes.

Rev. Rul. 91-26, 1991-1 C.B. 184. The amount that must be included in income is the cost of the premiums.  The ruling points out that if the payments are otherwise deductible as a trade or business expense under Code Section 162(a), they could be deducted by the S corporation.

Furthermore, the 2 percent shareholder, who is treated as a partner and therefore a self-employed individual under Code Section 401(c), may be entitled to deduct a percentage of the cost of the premiums under Code Section 162(l) to the extent the requirements of that section are met. For taxable years beginning in 1998 and 1999, the deductible amount is 40 percent, rising periodically to 100 percent for tax years beginning in 2007 and thereafter. Code Section 162(l)(1)(B). No deduction is allowed, however, for any month in which the taxpayer is eligible to participate (whether or not the taxpayer actually participates) in any subsidized health plan maintained by the employer of either the taxpayer or the taxpayer's spouse. Code Section 162(l)(2)(B).

OBSERVATION: Although Rev. Rul. 91-26 requires the inclusion of amounts paid by an S corporation for accident and health insurance covering a 2 percent shareholder in the shareholder/employee's income, the IRS has clarified that such payments are not wages for FICA (social security and Medicare) tax purposes. Announcement 92-16, 1992-5 I.R.B.

Solutions

Solutions are dependent upon facts & circumstances, law and the objectives.  These elements vary from one time to another, from one circumstance to another and from person or entity to another

Quotation from the IRS Code §162(L)

(l) Special rules for health insurance costs of self-employed individuals

(1) ALLOWANCE OF DEDUCTION

(A) IN GENERAL

In the case of an individual who is an employee within the meaning of section 401(c)(1), there shall be allowed as a deduction under this section an amount equal to the applicable percentage of the amount paid during the taxable year for insurance which constitutes medical care for the taxpayer, his spouse, and dependents.

(B) APPLICABLE PERCENTAGE

For purposes of subparagraph (A), the applicable percentage shall be determined under the following table:

For taxable years beginning The applicable

in calendar year-- percentage is--

--------------------------- ---------------

1999 and 2001 60 percent

2002 70 percent

2003 and thereafter 100 percent

(2) LIMITATIONS

(A) DOLLAR AMOUNT

No deduction shall be allowed under paragraph (1) to the extent that the amount of such deduction exceeds the taxpayer's earned income (within the meaning of section 401(c)) derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established.

(B) OTHER COVERAGE

Paragraph (1) shall not apply to any taxpayer for any calendar month for which the taxpayer is eligible to participate in any subsidized health plan maintained by any employer of the taxpayer or of the spouse of the taxpayer. The preceding sentence shall be applied separately with respect to--

(i) plans which include coverage for qualified long-term care services (as defined in section 7702B(c)) or are qualified long-term care insurance contracts (as defined in section 7702B(b)), and

(ii) plans which do not include such coverage and are not such contracts.

(C) LONG-TERM CARE PREMIUMS

In the case of a qualified long-term care insurance contract (as defined in section 7702B(b)), only eligible long-term care premiums (as defined in section 213(d)(10)) shall be taken into account under paragraph (1).

(3) COORDINATION WITH MEDICAL DEDUCTION

Any amount paid by a taxpayer for insurance to which paragraph (1) applies shall not be taken into account in computing the amount allowable to the taxpayer as a deduction under section 213(a).

(4) DEDUCTION NOT ALLOWED FOR SELF-EMPLOYMENT TAX PURPOSES

The deduction allowable by reason of this subsection shall not be taken into account in determining an individual's net earnings from self-employment (within the meaning of section 1402(a)) for purposes of chapter 2.

(5) TREATMENT OF CERTAIN S CORPORATION SHAREHOLDERS

This subsection shall apply in the case of any individual treated as a partner under section 1372(a), except that--

(A) for purposes of this subsection, such individual's wages (as defined in section 3121) from the S corporation shall be treated as such individual's earned income (within the meaning of section 401(c)(1)), and

(B) there shall be such adjustments in the application of this subsection as the Secretary may by regulations prescribe.