How Group Health Insurance Is Taxed for S Corporation Owners
An S corporation owner with more than 2 percent ownership is not treated like an ordinary employee. The corporation deducts the premiums, they are reported as wages on the owner’s W-2, and the owner takes an offsetting deduction on the personal return. Done correctly, the two entries largely offset for income tax. Done incorrectly, the deduction can be lost.
Three Steps That Have to Happen
Skip any one of them and the owner’s deduction is at risk.
The Corporation Pays and Deducts
The S corporation pays the premium, or reimburses the owner for it, and deducts it as a business expense. See how employers deduct group health premiums.
The W-2 Shows the Premium as Wages
The premium is reported in box 1 of the owner’s Form W-2 and is subject to income tax withholding. When the plan covers employees, it is generally not reported in boxes 3 and 5, so it is exempt from Social Security, Medicare and unemployment tax.
The Owner Deducts It Personally
The owner claims an above-the-line deduction on the personal return for the premiums, which offsets the W-2 inclusion for income tax purposes.
Conditions the IRS Attaches
These come from IRS guidance on S corporation compensation and medical insurance.
The Corporation Established the Plan
The premiums must be paid by the S corporation, or reimbursed by it and included in the owner’s W-2 wages. Under IRS Notice 2008-1, a policy the owner buys alone with personal funds produces no deduction.
No Other Subsidized Plan
The deduction is lost for any month the owner or the owner’s spouse was eligible to join an employer-subsidized plan, even without enrolling.
Wages From the Corporation
The owner must receive W-2 wages from the S corporation, and the deduction cannot exceed the earnings from the business that established the plan.
More Than 2 Percent Ownership
The rules apply to anyone who owns, or is treated as owning, more than 2 percent of the stock or voting power on any day of the year. Under the IRS constructive-ownership rules in Section 318, stock held by your spouse, children, grandchildren and parents counts as yours. A family member who owns no shares can therefore be treated as a more-than-2-percent owner. Siblings’ stock is not counted, and stock you hold only through family is not counted again as another relative’s. Confirm the details with your CPA.
Where S Corporation Owners Lose the Deduction
Premiums Never Reach the W-2
If the corporation pays the premium but it is never included in box 1, the personal deduction is at risk. This is a payroll reporting step, so it belongs on the payroll checklist at the start of the year.
Buying the Policy Personally
A policy in the owner’s own name, paid with the owner’s own money, does not qualify. The fix is to have the corporation reimburse the owner and report the amount as wages.
Using the Cafeteria Plan, an FSA or an HRA
A more-than-2-percent owner is not treated as an employee for cafeteria plan purposes and cannot take part in an FSA, HRA or QSEHRA on a tax-free basis. Employees can; the owner’s own premiums cannot go pre-tax through the plan.
S Corporation Owner Questions
Why is my premium on my W-2?
Federal rules require premiums paid for a more-than-2-percent owner to be reported as wages in box 1. That reporting is what makes the personal deduction available.
Does it raise my payroll tax?
Generally no. When the plan covers employees, the premium is exempt from Social Security, Medicare and unemployment tax even though it is included in box 1. See how the employee exclusion works for other employees.
Is the deduction on the corporation’s return or mine?
Both. The corporation deducts the payment it makes, and the owner deducts the premiums personally on the individual return.
Can I just buy my own policy?
Only if the corporation reimburses you and reports the amount as wages. A policy you pay for alone does not qualify.
Does the deduction cover my family?
The deduction can cover the owner, spouse, dependents and a child who is under age 27 at the end of the year, subject to the other requirements.
Who should confirm my situation?
Your CPA. We can set up the plan so the corporation pays and the premium is documented, and your CPA can confirm the W-2 and the return.
CFH are licensed insurance brokers, not tax advisors, and this page is general information rather than tax advice. Ownership, family relationships and how the business is taxed all change the result, so confirm your own treatment with your CPA. Our clients also have access to CPAs and attorneys through the firm.
Related Guides
Related reading: Tax Benefits of Group Health Insurance for Owners · C Corporation Owners · Sole Proprietors · Partners and LLC Members · Small Business Health Care Tax Credit · Section 125 Tax Savings Calculator
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