Health insurance for S corporation owners

Why owners are treated differently

Employees usually get health insurance from their employer tax-free. An owner of more than 2% of an S corporation doesn't: for fringe benefits, the tax code treats them like a partner, not an employee. Family counts toward the 2% — a spouse, child, grandchild or parent of an owner is treated the same way. So the premiums can't simply be a tax-free benefit. There's a specific route instead.

How it works, in four steps

1. The S corporation sets up the coverage. Either it buys the policy, or you buy one in your own name and the corporation reimburses you for the premiums. Both count, as long as the corporation pays or reimburses.
2. The premiums go on your W-2 — in box 1 only. They're wages for income tax, but because they're health insurance under a plan for employees, they aren't subject to Social Security, Medicare or unemployment tax. They don't go in boxes 3 and 5.
3. The corporation deducts them as wages, which lowers the profit that passes through to you.
4. You deduct them on your own return as the self-employed health insurance deduction — above the line, so you don't need to itemize.

The W-2 wages and the deduction cancel out, and the corporation's deduction lowers your share of its profit. Net effect: the premiums come out of your taxable income, with no payroll tax on them.

The mistake that loses the deduction

Paying the premiums from your personal account, with no reimbursement from the corporation. Then the plan isn't established by the S corporation, and the IRS says the deduction isn't allowed. The premiums might still count as an itemized medical expense, but only above 7.5% of your income — which for most owners means nothing. Fix it by having the corporation reimburse you, and making sure the premiums reach your W-2 by year-end.

The limits

• Up to your salary from the S corporation — its Social Security wages, not counting the premiums. A very low salary can cap the deduction.
• Not for months you could join a subsidized employer plan — including one through your spouse's job — even if you don't enroll in it.
• It covers you, your spouse, your dependents, and children under 27.
• If you take the QBI deduction, the corporation's deduction for the premiums shrinks it a little, so the saving is slightly less than your full rate.

What it's worth

If you're a sole proprietor or partner

You take the same self-employed health insurance deduction, without the W-2 step. For a partner, the partnership pays the premiums and reports them as guaranteed payments. Either way, the deduction lowers income tax but not self-employment tax.

When it doesn't fit

• You're eligible for a subsidized plan through your own job or your spouse's.
• Your W-2 salary from the corporation is smaller than the premiums.
• You own 2% or less — then you're treated as an ordinary employee, and the premiums can be a tax-free benefit.

Health savings accounts and other benefits have their own rules for owners — worth going through with your CPA or tax attorney, along with whether your setup qualifies.