What You're Doing Wrong with S Corporation Health Insurance Premium

business tips irs s corporation

Today, I wanted to address a common mistake with S Corporations, and how owners/shareholders often incorrectly deduct their health insurance premiums.

I'll give you a high-level overview of how this works within an S Corporation structure – no deep dive, just the essentials you need to know. This blog post is perfect for those seeking a clear, straightforward summary without getting bogged down with the details.

So, let's get right to it and uncover how you can make the most of your S Corporation benefits!

Owners in an S Corp will often, incorrectly, pay their employee shareholder’s health insurance premiums directly through the company, and do nothing else, thinking everything is fine.

Although, it’s reasonable to think that… This is wrong and would not be accepted by the IRS. There’s much more to it than that.

Allow me to explain.

As a (more than 2%) owner or shareholder of an S Corporation, you have a unique position when it comes to tax benefits, and one of those benefits is how you can handle your health insurance premiums. Typically, health insurance premiums are a personal expense. But in the case of S Corporations, they are treated differently.

First off, it's important to understand that if your S Corporation pays for your health insurance, it's considered a taxable fringe benefit.

However, this doesn't mean you lose out. Instead, the amount paid by the S Corporation for your health insurance - will need to be included in your W-2 wages.

This inclusion turns it into a legitimate business expense for the corporation while also giving you, the shareholder, the chance to claim a self-employed health insurance deduction on your personal tax return.

I know that’s a little complicated, so…

Let me break that down into steps:

In this example, we have an S Corporation with one shareholder working in the business.

Step 1. The company buys group health insurance for the employee shareholders. Let’s say it costs $5,000.

It’s important to note that the health insurance plan must be opened as a company plan unless it’s not permitted by state law. 

Also, if you or your spouse are eligible for health insurance coverage through an employer, then this
wouldn't work for you.

Step 2. Let the Payroll Company Know About the Health Insurance Premiums. Sometime before the end of the year, you need to let your payroll company know about the health insurance premiums for the more than 2% shareholder. They will add this to the employee-shareholder’s W2 amount, as taxable income to them, but keep in mind, and this is important, it's not subject to payroll taxes, which is about 15.3%.

Step 3. When the employee shareholder files his or her taxes, the $5,000 would already be included on his or her W2, as taxable income. But they can also take a self-employed health insurance deduction for $5,000 on Schedule 1 of Form 1040. This effectively zeros out any taxability of the health insurance benefit, on the personal level.

You might be wondering..
How would someone know about the $5,000 health insurance deduction?

This should be reported on the individual's K1. The shareholder’s share of income, deductions, and credits.

The beauty of this setup is that it allows the S Corporation to deduct the cost of the premiums as a business expense, while you lower your personal taxable income through the self-employed health insurance deduction.

It's a win-win situation!

Now, these are a lot of hoops to jump through, but that’s what you need to do if you don’t want to have any problems with the IRS, and if you want to properly deduct your health insurance premiums through your S Corp.

So, keep in mind, that the insurance plan must be established under your S Corporation, and the deduction can't exceed the earned income from your S Corporation. These are just a couple of the high-level points to be aware of.

Remember, every S Corporation's situation is unique, so it's always wise to consult with a tax professional to get advice tailored to your specific circumstance.

One other thing to note is if you’re self-preparing your own S Corporation tax return, as a non-tax professional. I would strongly caution you not to do it. There are too many rules and requirements, that are often overlooked or missed. I made a blog post on why you shouldn't self-prepare your S Corporation tax return that you can read here.

And there you have it, a quick overview of how S Corporation owners and shareholders can approach health insurance premiums for optimum tax benefits.

I hope this blog post has given you a clearer understanding of your options and the advantages you can leverage as an S Corporation business owner. That's it for today, I hope you found this informative.

Thanks for reading and see you in the next blog post!

About The Author

Noel Lorenzana is an Illinois-licensed, Registered Certified Public Accountant with over 20 plus years of experience.

Through his online educational content, YouTube videos, easy-to-understand courses and 1-on-1 consulting, he gives you the tools to become tax savvy for yourself. 

Disclaimer: Any accounting, business or tax advice contained in this article, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.