How S-corp owners can deduct health insurance
Health Benefits • January 20, 2023 at 9:25 AM • Written by: Elizabeth Walker
Choosing an S-corporation to form your business comes with several impressive tax advantages. You don’t pay corporate income taxes, and your social security and Medicare taxes are lower. Profits are allocated to corporation shareholders and taxed at that point.
However, health insurance for an S-corporation’s team members can be a tricky matter. While S-corp employees can claim tax-free health insurance, shareholders who own more than 2% of the company stock can’t access this same perk. For these individuals, S-corp health insurance deduction is more complicated.
This article will go over the detailed steps S-corp owners must take to receive company-sponsored health insurance, how to properly deduct those expenses from their taxes, and how flexible medical benefits affect their eligibility.
Find out how HRAs can work for your employees in our complete guide
As an owner, can my S-corp pay my health insurance?
Many people assume all business types can provide health insurance to their employees, including owners, tax-free. While this is true for C-corporations, it isn’t the case for S-corps.
S-corporations can provide health insurance as a tax-free benefit to their non-owner employees and deduct the cost as a business expense, paying no taxes on the insurance premiums. However, getting tax-free health insurance for S-corp owners isn’t quite so easy.
Shareholders owning outstanding stock greater than 2% must include any health insurance costs paid through the company as income, according to Internal Revenue Code Section 707(c)1, making the amount subject to income tax.
However, the amount is free from Medicare, unemployment, and social security taxes if the payments are made on behalf of the shareholder under a health plan that provides for all employees or a class of employees.
Unlike business owners of an LLC or partnership, S-corp owners can’t get around this rule by employing their spouse and getting coverage through their participation in the health insurance plan.
For health insurance purposes, spouses and other family members of an S-corp owner act as S-corp owners themselves, even if the family members don’t have any stock in their names.
Can an S-corp owner deduct health insurance?
While S-corp owners may not have the same access to tax-free health insurance coverage as their employees, they can still receive tax-advantaged premiums. They can do this by taking a personal income tax deduction on the health insurance premiums paid by the company.
For S-corp owners to qualify for the health insurance deduction, the company must establish their policy—not the individual S-corp owner.
To determine whether the health insurance policy is established by the business, the IRS considers:
- Who pays policy premiums
- How the health insurance premiums are reported for income tax purposes by both the company and the S-corp owner
To qualify, the company must pay the S-corp owner’s insurance premium, including the premiums as gross wages in the S-corp owner’s Form W-2. The company must either make the premium payments directly to the insurance company or reimburse the S-corp owner.
If the S-corp owner pays the policy premiums on their own, without reimbursement by the business, this doesn’t qualify the owner for a tax deduction for health insurance. If the owner does qualify, they can make an S-corp deduction with Form 10402.
Under this method, S-corp owners can deduct premiums for accident, dental, long-term care policies, and health insurance policies.
How do health reimbursement arrangements (HRAs) affect S-corp owners?
Many S-corp owners want to know how these rules affect their eligibility to participate in a health reimbursement arrangement (HRA) because HRAs are tax-free employee fringe benefits.
Because HRAs are only eligible for W-2 employees, and S-corp owners are taxed as shareholders, S-corp owners and their families aren’t considered employees. Therefore, they aren’t allowed to participate in an HRA.
Some S-corp owners want to participate in an HRA to track their expenses, but this isn’t permitted either. HRAs function as a reimbursement benefit, and when insurance policy premiums are reimbursed, they aren’t considered “established by the business.”
This means S-corp owners and their families can’t deduct those medical expenses even if they participate in the HRA for tracking purposes.
However, S-corp owners can still offer an HRA to non-owner employees. HRAs allow the corporation owner to have complete control over their budget while giving employees the freedom to choose how they spend their healthcare allowance.
How do fringe benefits affect S-corp owners?
Stipends, or taxable employee fringe benefits, are a popular benefits option for businesses of all sizes. If you’re an S-corp owner interested in offering a health stipend because of their more relaxed rules, you might wonder if you can participate.
As an S-corp, you can offer taxable fringe benefits to cover medical expenses to your employees as taxable income. As an S-corp owner, you can also participate in your taxable health stipend benefit as long as you include it as additional income.
Health stipends for S-corp shareholders are subject to FICA, FUTA, FITW, and SITW. Taxable fringe benefits may be deductible as additional wages and salaries on Form 1120S3, but they must be reported as taxable income to do so.
As a business owner, handling your income tax return can take significant time and effort. Contact your tax advisor or accountant if you need tax advice with personal deductions, benefits costs, or tax liability.
Conclusion
S-corp owners' health insurance doesn’t function as a tax-free fringe benefit the same way C-corp owners’ do. However, they can still access tax-advantaged health insurance through the company. If S-corp owners established their policy through their business, they could deduct any premium payments on their Form 1040 when they file taxes at the end of the year.
In the meantime, they can offer their employees a quality health insurance benefit with a traditional group policy, health stipend, or an HRA. If you’re interested in offering your employees an HRA or employee stipend, PeopleKeep can help! Schedule a call with a personalized benefits advisor to see how a health benefit can work with your S-corp organization.
This article was originally published on May 14, 2019. It was last updated on January 20, 2023.
1. https://www.law.cornell.edu/uscode/text/26/707
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Elizabeth Walker
Elizabeth Walker is a content marketing specialist at PeopleKeep. Since starting with the company in April 2021, she has become well-versed in writing about HRAs, health benefits, and small business solutions. Outside of her expertise in the healthcare benefits industry, Elizabeth has been a writer for more than 20 years and has written several poems and short stories. She's published two children’s books in 2019 and 2021, which she is developing into a series of collected works. Her educational background as a classical musician and love of the arts continue to inspire her writing and strengthen her ability to be creative.