The IRS code section related to fringe benefits allows employers (in most cases) to deduct the cost of fringe benefits, while employees may exclude those amounts from their gross income. Employer paid health insurance costs are an example of such costs. However, while it seems like deducting health insurance premiums for a shareholder/employee of an S corporation should be a simple matter, only the tax law can make something that should be simple, complicated.
The problem goes back many years and arose soon after S corporations became part of tax law. Initially, S-corporations were viewed as similar to partnerships, and there was a prohibition on deducting certain fringe benefits of partners. Thus, a deduction was denied to S corporations for certain fringe benefits, most importantly health insurance, paid on behalf of S corporation shareholders. Well, not all shareholders, only those owning more than a 2% interest.
Approach. Health insurance of a 2% shareholder isn’t deductible by the corporation unless it’s included in the shareholder-employee’s income. Thus, the approach to make it a deductible expense by the corporation is to include the income on the shareholder’s W-2. At this point it’s a wash – the corporation gets a deduction and the shareholder has income (of course, the deduction is “passed through” to the shareholder). In the final step the shareholder deducts the premiums on his Form 1040, making the insurance premiums deductible.
Corporation or shareholder’s plan? What if the plan isn’t exactly 100% paid for by the corporation? The plan providing for coverage is established by the S corporation if:
- The S corporation makes the premium payments for the health insurance policy covering the 2% shareholder-employee (and his or her spouse or dependents, if applicable) in the current taxable year, or
- The 2% shareholder makes the premium payments and furnishes proof of the payment to the S corporation and the S corporation reimburses the shareholder-employee for the premium payments in the current tax year.
If the accident and health insurance premiums are not paid or reimbursed by the S corporation and included in the 2% shareholder-employee’s gross income, a plan providing medical care coverage for the shareholder is not established by the S corporation and the shareholder is not allowed the deduction.
In order for the shareholder to deduct the amount of the premiums, the S corporation must report the premiums paid or reimbursed as wages on the shareholder-employee’s Form W-2 in that same year. In addition, the shareholder must report the premium payments or reimbursements from the S corporation as gross income on his or her Form 1040.
Examples. It always helps when one has an example to clarify the various scenarios that may be encountered. In the examples below, Goofball Inc. is an S corporation and Jeb and Bobbi Joe are 2% shareholder-employees.
- In 2012 Jeb, a shareholder in Goofball Inc., obtains an accident and health insurance policy in his name and makes the premium payments on the policy. Goofball makes no payments or reimbursements with respect to the premiums. In this case a plan providing medical care for Jeb has not been established by the S corporation and Jeb is not entitled to the deduction under Sec. 162(l).
- In 2012 Goofball obtains a health insurance plan in the name of Goofball. The plan provides coverage for Jeb, his spouse, and dependents. Goofball makes all the premium payments to the insurance company. Goofball reports the amount of the premiums as wages on Jeb’s Form W-2 for 2012 and Jeb reports that amount as gross income on Form 1040 for 2012. In this case a plan for providing medical care for Jeb has been established by Goofball and Jeb is allowed the deduction under Sec. 162(l).
- For 2012, Bobbi Joe obtains a health insurance policy in her name. Goofball makes all the premium payments to the insurance company. Goofball reports the amount of the premiums as wages on Bobbi Joe’s Form W-2 and Bobbi Joe reports that amount as gross income on Form 1040. In this case a plan providing medical care for Bobbi Joe has been established by Goofball and Bobbi Joe is allowed the deduction under Sec. 162(l).
- For 2012, Bobbi Joe obtains a health insurance policy in her name. She makes the premium payments to the insurance company and furnishes proof of premium payment to Goofball. Goofball then reimburses Bobbi Joe for the premium payments. Goofball reports the amount of the premiums as wages on Bobbi Joe’s Form W-2 and Bobbi Joe reports that amount as gross income on Form 1040. In this case a plan providing medical care for Bobbi Joe has been established by Goofball and Bobbi Joe is allowed the deduction under Sec. 162(l).