Tax deductions - Medical Expenses for S-Corp Shareholders
One of the S-corporation tax deductions that are often overlooked by S-corp owners is health insurance premiums.
S-Corp shareholders can deduct medical expenses for themselves, their spouse, and dependents on Schedule A as itemized medical expense deductions, if they are over 7.5% of adjusted gross income or unreimbursed expenses exceed 10% of adjusted gross income.
In addition to health care premiums, S corporation shareholders may be able to deduct out-of-pocket medical costs such as co-pays, prescriptions, and doctor visits.
However, unlike S-corporation employees, who can simply claim employee health insurance as a tax-free benefit, the process for S-Corp owners to receive company-sponsored health insurance and still deduct it from their tax bill is more complicated.
In this article, we’ll be setting out how medical insurance can be claimed as a personal expense by S corp owners and how to make that happen.
Health insurance isn't a tax-free fringe benefit for S corp owners
Unlike a C corporation, S corp shareholders are not employees and therefore cannot receive health insurance as a tax-free benefit. S corporations do provide some flexibility, which allows S corporation owners to deduct 100% of their medical expenses
However, S corporation owners must first calculate the related business deductions that apply to those expenses in order for them to then be able to make them tax-deductible. This process is far more complicated than simply taking an employee health insurance deduction on Schedule C.
While it's more complicated, it certainly isn’t impossible, it simply means the S corporation has to pay the healthcare premiums and other associated expenses for the S corporation owner as part of their reasonable compensation for working for the corporation. Simply put, the health insurance premiums will need to be added to the W2 wages of the shareholder.
Allowing healthcare as a 'reasonable compensation'
If you are a greater than 2 percent shareholder in an S corp, you are required to state the cost of health insurance paid through by business as income, as per Section 707(c) of the Internal Revenue Code.
In order to claim S Corp deductions, the S corporation must have a written reimbursement plan in place for reimbursing shareholders as part of their reasonable compensation.
The S corp also needs an accounting method that allocates business expenses to shareholders based on their pro-rata share of stock ownership.
The S corporation must provide its owner with a written notice that the S Corporation is going to include the cost of health insurance as part of shareholders' wages, or an allocation policy that includes these payments.
Personal deduction for health insurance premiums
Once the S corporation has a written notice that the S Corporation is going to include the cost of health insurance policy as part of shareholders' wages, or an allocation policy that includes these payments, S corporation shareholders can deduct the premiums from their personal income taxes.
This is because self-employed people are allowed to deduct health insurance premiums from their income tax.
S corporation shareholders with more than 2% of the company stock are considered self-employed for tax purposes. The S corporation's earnings pass through to their personal returns which means they are eligible to claim the S corporation's deductions.
It should be noted that this is not a business deduction, but a personal deduction and therefore must be included on the first page of Form 1040 as self-employed health insurance.
In order to claim this deduction, S corporation shareholders must have earned more than one-half of their total income from an S corporation business and they can't be claimed as a dependent on another person's tax return.
They also need to keep proper documentation just in case the IRS decides to audit them. This is why is important to keep documents of any income tax withholding, federal income tax, along with medical care coverage receipts and medical bills.
Finally, it should be noted that S corporation owners who are over age 65 or retired due to permanent disability may deduct premiums paid for Medicare Parts B & D along with other medical expenses as an itemized deduction. In fact, those deductions will help reduce adjusted gross income which could increase eligibility for several popular tax credits.