NEW! 2013 Update Post
The following is an excerpt from my book, The Pocket Small Business Owner’s Guide to Taxes, and is important information for S corporation shareholders as 2012 is starting to wind-down. This is especially important if you use a payroll processing company, as they will need to include your health & dental insurance on your last payroll run. This is a time-sensitive matter, and failure to report your premiums correctly can be a very costly mistake.
The reporting of health insurance premiums for a more than 2 percent S corporation shareholder can be a little confusing; however, it is crucial that it is reported correctly if you want to maximize your deduction. If you miss a few simple steps before the end of the year, you could end up limiting or losing your deduction all together.
The self-employed health insurance deduction allows self-employed individuals to deduct their health insurance premiums on the front of the 1040 as an adjustment against income. Even though an S corporation shareholder is not technically self-employed, the IRS requires a more than 2 percent S corporation shareholder to report the deduction as if they were self-employed and not on the S corporation return.
Simple Steps to Maximize Your Deduction
Below are the steps that have to be taken in order to get the self-employed health insurance deduction. Make sure you follow them closely as an error can result in the loss of substantial tax savings.
- An S corporation cannot deduct health, dental, and other medical premiums for a shareholder who owns more than 2 percent. Their premiums should be tracked separately in the accounting system throughout the year.
- If the corporation did not pay the premiums during the year, make sure the corporation reimburses them before the end of the year.
- Before the final payroll run of the year, calculate the total shareholder health, dental, and other medical insurance premiums paid or reimbursed by the corporation as this figure will be needed for the final payroll and the shareholder’s W-2.
- The amount of premiums for the year is paid to shareholder as payroll, but there is special payroll tax treatment for this payment. The amount is subject to Federal and State withholding, but it is not subject to social security or Medicare tax. If you use a payroll service, they will have a pay item for this specific payment.
- On the W-2, the amount of the premiums is recorded in box 1 wages, in the state wages, and in box 14 as “S/H Health Ins” or a similar description.
- Finally, on the shareholder’s individual tax return, make sure the amount of shareholder health insurance is deducted as self-employed health insurance on the front of Form 1040.
The end result is that the payroll payment for the premiums is deducted as a wage on the corporation return, the wage is taxed as income on the individual return, and the self-employed health insurance deduction is taken on the personal return, which all nets out to a deduction in the amount of the premiums. This may seem like a whole lot of unnecessary paperwork, but it is much better than the treatment that results if you do not follow these steps.
Tax Consequences of Incorrect Reporting
If a more than 2 percent shareholder fails to include their health insurance premiums on their W-2, technically the IRS will not allow the self-employed health insurance deduction on the individual return, and the shareholder would have to claim the premiums as a medical expense on Schedule A, which unfortunately is subject to a haircut of 7.5% of adjusted gross income (10% starting in 2013). This means that your deduction is reduced by an amount equal to 7.5% of your adjusted gross income, and if there is anything left then you get a deduction for the remaining amount. If you run the numbers, this is huge loss of deduction and a horrible penalty for not following the IRS rules.
Given the high cost of health insurance premiums these days, it is very important that you make sure and follow the steps listed above each year. Have your tax professional help you and do not wait until tax time as amended W-2s can be costly to prepare.
For more S corporation shareholder tax advice like this, refer to Chapter 9 in my book.