S Corporation payments or reimbursements of health and accident insurance premiums paid on behalf of a greater than 2% S corporation shareholder are subject to special rules which require careful attention. In order to preserve a tax deduction for the greater than 2% S corporation shareholder, it is important to comply with these rules.
Health and accident insurance premiums paid on behalf of a greater than 2% S corporation shareholder-employee are deductible by the S corporation and reportable as wages on the shareholder-employee’s Form W-2, subject to income tax withholding. However, these additional wages are not subject to Social Security or Medicare taxes, or unemployment taxes if the payments of premiums are made to or on behalf of anemployee under a plan or system that makes provision for all or a class of employees (or employees and their dependents). Therefore, the additional compensation is included on the shareholder-employee’s Box 1 (Wages) of Form W-2, but not in Boxes 3 and 5 of the Form W-2.
For purposes of the above rule, the determination of who is considered a greater than 2% S corporation shareholder is made taking into consideration the constructive ownership rules of section 318 of the Internal Revenue Code. Accordingly, stock owned by a spouse, child, grandchild, or parent is considered owned by the taxpayer.
A greater than 2% S corporation shareholder-employee is eligible for an above-the-line deduction in arriving at Adjusted Gross Income for amounts paid during the year for health and accident insurance premiums if the coverage was established by the S corporation and the shareholder met the other self-employed medical insurance deduction requirements.
When health insurance is purchased in the name of the shareholder, IRS Notice 2008-1provides that for the shareholder-employee to obtain the above-the-line deduction for those health insurance premiums, the S corporation must either directly pay the health insurance premiums or reimburse the shareholder for those premiums. In such situations, the amount of the premiums paid directly or reimbursed by the S corporation must be included in the shareholder-employee’s Form W-2. In this situation, the employer deducts the premiums paid or reimbursed as compensation expense.
The bottom line is that in order for a greater than 2% S corporation shareholder-employee to claim an above-the-line deduction, regardless of whether the S corporation pays the health and accident insurance premiums directly to the insurance company or reimburses the shareholder-employee for those premiums, the health and accident insurance premiums must ultimately be paid by the S corporation and must be reported as taxable compensation in the shareholder’s Form W-2.
It should be noted that a 2% S corporation shareholder-employee’s above-the-line deduction for health and accident insurance premiums is further limited to the amount of Medicare wages they receive from the S corporation.
It is also important to note that if the greater than 2% S corporation shareholder or the shareholder’s spouse was eligible to participate in any subsidized health care plan, then the shareholder is not entitled to the above-the-line deduction.
As can be gathered from the above, the rules for reporting and deducting health and accident insurance premiums paid on behalf of greater than 2% S corporation shareholders is complicated. It is very important that these rules be fully complied with in order to maximize the deduction of these premiums. If you have questions or need assistance with these rules, please contact us.