[UPDATE DEC 2011: We have been told by a seminar presenter that for 2011 and beyond, S corps should report health insurance for shareholders on W-2 in Box 12 with DD code instead of Box 14 as in the past…we are going to research this a tad more…but there you have it for now. Also, the presenter indicated that the IRS was NOT happy about year end journal entries for health insurance…that IRS wants to see monthly/quarterly payments…but again…that is not definitive/law. More when we have something certain. And if YOU have more info, please post so we can all get in on the search for the truth :).]
S Corporation Shareholders – if you own 2% or more of the stock in your S corporation, now is the time to make sure that you have reported your health insurance correctly in order to get the best deduction. Even though the law was enacted and clarified late in 2007 (Notice 2008-1), we are still seeing errors on Forms K-1 and W-2s coming from payroll companies and our fellow accountants – and those errors are expensive to fix after December 31.
[Please note – if you have been purchasing health insurance coverage for your employees, the expense is deductible as health insurance and is generally not taxable to your employees. This blog does not address issues involving health insurance for your employees.]
The problem addressed by Notice 2008-1 is the “more-than-2%-shareholder-employee’s” expense. That is YOUR health insurance if you are, for example, the sole owner of your company. Here are the steps to ensure deductibility at both the corporation and personal levels:
- Shareholder-Employee. If your company is profitable, you should be paying yourself “reasonable” compensation – that is the law. Compensation is payroll, complete with payroll taxation. In order for health insurance premium expense to be deductible at the company level, it must not exceed your personal earned income. Thus, you must have wages from your company in order to be eligible to have health insurance paid by the company. If your wages are $10,000, then you could have health insurance of $10,000. That makes sense, doesn’t it? If you are not an employee of a company or a dependent of an employee, why on earth would the company pay your insurance for you? If your company is not profitable, you are not required to take payroll, but then your health insurance is not deductible at the company level (you can still take it as a distribution and deduct it on Schedule A Itemized Deductions).
- Who Owns the Accident and Health Plan? Much confusion here was explained in Notice 2008-1. The company can own a group plan or you can own an individual plan. Important: the company must pay for the premiums either directly or as a reimbursement to you, the shareholder, for your personally owned policy. Do not fail to have the company reimburse you if you buy an individual policy. If the company does not reimburse you, the company cannot take the deduction – and you lose. You can, however, still take Schedule A Itemized Deduction.
- Bookkeeping. On your corporation books, you will have expense for health insurance whether you pay it directly or you reimburse yourself. It is a company level expense/deduction. It is NOT a distribution to you. Ultimately, it becomes a payroll expense, deductible ONLY at the corporation level.
- Payroll Reporting. During the year, when you file your payroll quarterly reports (Form 941 and your state unemployment reports), you will report your health insurance premiums as PAYROLL that is NOT subject to Social Security or Medicare. You will also not be subject to federal and generally state withholding (check on your state…in Colorado, you are not subject to withholding).
- W-2 Year End. Your W-2 will include health insurance premiums in your gross Box 1 wages, but will NOT include the premiums in Box 3 or Box 5 (Social Security and Medicare). You should also see your health insurance premiums in Box 14 as S Corp Health/Medical Insurance. If your accountant reports your health insurance premiums as a K-1 distribution item, you may ONLY take a Schedule A Itemized Deduction and NOT a page one deduction. It is imperative that your health insurance premium be reported on your W-2 to assure the best tax treatment.
- Your 1040. You will report your total Box 1 wages on your personal tax return. And then you will take a Page One deduction for the health insurance premiums. The result is a wash. This is correct. Bizarre, but correct. It’s not the way we would have done it. But it is what it is. Read on.
THE ACTUAL DEDUCTION IS TAKEN AT THE COMPANY LEVEL ONLY, so your total ordinary income reportable on your K-1 will be reduced by the health insurance deduction. If this seems like a complicated way to take a deduction, we agree with you! We have no idea why Congress and the IRS made this so difficult, but we do know that if you follow these procedures, your health insurance payments receive a good deduction and if you DO NOT follow these procedures, you are limited to a Schedule A Itemized Deduction—generally not a good deduction.
CHECK NOW with your bookkeeper/accountant/payroll service to make sure that you will be able to claim the health insurance deduction. If you wait until your payroll reports are finalized, all may have to be amended. Messy and expensive!