IRS Disallows Health Insurance Deduction for Some S-Corporation Shareholders

In an unusual ruling by the IRS, employees who are shareholders in an S-Corporation might not be able to claim an above-the-line tax deduction for health insurance premiums. This move could cost entrepreneurs who own and operate S-Corporations an extra $1,250 in federal income taxes, according to Russ Fox over at Taxable Talk.

Self-employed individuals typically struggle to afford health insurance, and the tax code provides a nice tax break for corporations that provide health insurance benefits for their employees. Health insurance premiums are exempt from FICA payroll taxes. For employees, health insurance can be paid for with pre-tax dollars, making the insurance a tad more affordable for everyone. Employees who own 2% or more of an S-Corporation, however, have to follow different rules for figuring income and tax deductions. The IRS holds that shareholder-employees will be allowed the deduction for health insurance premiums only if the S-Corporation establishes the health insurance plan and purchases the coverage. Shareholder-employees who purchase coverage under their own name cannot use the above-the-line deduction, but can still include the premiums as an itemized deduction, subject to the limitations on medical expenses.

Russ Fox, an enrolled agent who writes over at Taxable Talk, estimates that a typical S-Corp shareholder-employee would pay an extra $1,250 in taxes if health insurance was purchased personally instead of through the corporation. The kicker? "Many states, including California, do not allow single-employee corporations of any kind to obtain health insurance," says Mr. Fox. He urges entrepreneurs to write to their Congressional representatives. That sounds like a good idea to me.

Learn more about: health insurance deduction for self-employed persons, itemized deductions, S Corporations.
Link to IRS Announcement: Health Insurance Covering S Corporation Shareholders.