June, 2007 Tax Tip
Health Insurance for Solely-Owned Businesses
In many solely-owned businesses, then owner of the business will purchase health insurance in his or her own name, rather than in the name of the business. The type of entity may have great impact on where the premium may be deducted on the owner’s personal tax return and, accordingly, how much may be deductible. This month’s Tax Tip briefly discusses the tax treatment of the premium in the cases of a sole proprietor and an S corporation.
The Tax Code provides that a self-employed individual (sole proprietor) who purchases health insurance in his or her own name can treat the insurance as purchased in the name of the proprietorship. The self-employed person is considered an employer for this purpose and can, therefore, deduct 100% of the insurance premiums paid for himself, spouse, and dependents as an adjustment to income (“above-the-line deduction”). This is rather well-established tax law.
The situation becomes a little more muddied if the solely-owned business is an S corporation. If the insurance is purchased by the corporation, tax law provides that the corporation will be treated as a partnership and a more than 2% shareholder will be treated as a partner. Resorting to the pertinent partnership tax provisions and related revenue rulings, health insurance premiums paid by a partnership on behalf of a partner are considered guaranteed payments if paid for services rendered by the partner to the partnership. As such, they are deductible by the partnership and includible in the partner’s gross income. In the context of an S corporation, the payment of the premiums would be deductible as compensation and includible on the shareholder’s W-2. Where, on his return, does the shareholder now deduct the premiums?
For purposes of employee fringe benefits, including health insurance premiums, a shareholder who is treated as a partner (see preceding paragraph) will be treated as a self-employed person and, therefore, may generally deduct the insurance premium as an above-the-line deduction.
If the insurance is purchased by the shareholder in his own name instead of that of the corporation, the corporation has not established a plan to pay a fringe benefit to its shareholder. Therefore, the partnership provisions do not come into play. Since the shareholder is not treated as a partner, he is not treated as self-employed and is not eligible for the above-the-line deduction. However, he is still able to deduct the premiums as a medical expense on Schedule A, subject to the 7.5% AGI limitation.
Tax Tip: In the context of an S corporation, the health insurance should be purchased in the name of the corporation in order for the shareholder to obtain an above-the-line deduction. There is a caveat – some states do not allow a corporation to purchase a group health plan with only one participant.
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