If your S Corporation pays for medical insurance for employees, it will be a 100% deduction for the company and not taxable for the employee. If you own >2% of the shares of the S Corporation, you don’t get the same tax break. In fact, the amount paid for the medical insurance by the corporation should be added back to the owner’s tax return. The owner then can take a deduction on his Form 1040 (maybe).
It’s confusing, and doesn’t make a lot of sense, but here’s how medical insurance deductions work for an S Corporation according to IRS issued Notice 2008-1. (http://www.irs.gov/pub/irs-drop/n-08-01.pdf)
In short, medical insurance paid under individual medical insurance plans may be deductible “above the line” if the following conditions are met:
- The corporation must establish a “plan” for the payment of medical insurance premiums on behalf of the shareholder-employee.
- The corporation must either pay the premiums for the plan, or reimburse the employee-shareholder for the premiums paid after being provided proof of premium payment to the S corp.
- Premiums so paid or reimbursed on behalf of the shareholder-employee MUST BE ADDED TO W-2 BOX 1 WAGES. These premiums should be EXCLUDED from Box 3 Social Security Wages and Box 5 Medicare Wages (thus they are exempt from FICA taxes completely).
- On the 1120S for the S corporation, the corporate tax return will include a deduction for wages/compensation paid which includes the medical insurance paid on behalf of the shareholder employee.
- On the shareholder-employee’s 1040 an above the line deduction will be taken for the medical insurance paid by the corporation which were added to the W-2. In Notice 2008-1 the IRS states that if this treatment is not followed, the medical insurance deduction “above the line” will be disallowed and the deduction will be moved to Schedule A. If this happens, the value of the deduction is generally severely limited due to the 7.5% threshold that must be exceeded before medical expenses are allowed.
ACTION ITEMS TO TAKE ADVANTAGE OF THIS DEDUCTION:
- Document the existence of your corporation’s “plan” by making note of it in your annual minutes.
- If you have paid the medical insurance individually, gather up all of your medical insurance payments for 2014 and submit a reimbursement to your corporation to reimburse yourself for those amounts. Post the reimbursement check to “Officer Wages” or similar gross pay expense account.
- Contact your payroll company to provide them with the information necessary to include the medical insurance expense (directly paid by the corporation or reimbursed to the shareholder) in your final paycheck and your W-2 for 2014.
If you’ve already issued the W-2s, you can create amended ones to correct the medical insurance issue.
Now let’s talk about what a 2% shareholder is. If you owned more than 2% of the stock in the company on any day during the tax year, you’re a 2% shareholder.
There are also attribution rules. Your spouse, children, grandchildren or parents all are considered 2% owners if you own >2% of the shares for any day in the tax year. That means you child would be considered an owner, but your brother would not.