*** Warning: This blog is not exciting but is important for S Corp owners that want to deduct their health insurance costs on their personal tax return. The IRS has increased the compliance requirements, so we are publishing detailed instructions on how to comply. Please subscribe for more exciting content in the future***
If you own an S Corporation, here’s a quirky but important rule:
When your business pays for your health insurance (and your spouse and dependents), it must show up on your W-2 in Box 1 as opposed to Boxes 3 or 5.
Yes, that means your W-2 income looks higher than it really is. And yes, it’s as strange as it sounds. But it’s the only way to receive the self-employed health insurance deduction on your personal tax return.
The IRS wants your S-Corp to:
So, you pay income tax on it, then get the deduction back.
Why? Because the IRS said so. (We don’t make the rules — we just help you avoid paying more than you should.)
Let’s say you pay yourself a $300,000 salary and your S-Corp pays $30,000 of health insurance. Here is how your W2 will look after the year is over.
|
W-2 Box |
Description |
Amount |
|
Box 1 |
Wages, tips, other compensation |
$330,000 ($300k + $30k) |
|
Box 3 |
Social Security wages |
$300,000 |
|
Box 5 |
Medicare wages |
$300,000 |
|
Box 14 |
Notes (optional) |
“S Corp Health Ins $30,000” |
On your personal return, you then deduct the $30,000 as self-employed health insurance via Form 7206 (we handle the filings for our tax clients).
It all cancels out, but if you skip the W-2 step, you lose the deduction. That could mean paying more in federal tax because of improper labeling on your W2.
Here’s how to handle this properly in ADP Run (our recommended payroll service):
Go to Setting → General Settings→ Features and Services and make sure the “S Corp” option is turned on.
Go to Settings → Payroll → Earnings & Deductions.
Click Add Earning, then choose Fringe Benefit → S-Corp 2% Medical Plan.
Mark the employees that are > 2% shareholders / officers.
Ensure the benefit is subject to federal income tax (FIT), but not Social Security, Medicare, FUTA, or unemployment
When you run your final payroll of the year, add the total amount of company-paid or reimbursed premiums under S-Corp 2% Medical Plan earning type (for each shareholder).
S-Corp owners may consider entering the premiums once per year in December to simplify the process.
Hours and Earnings should show both Regular wages and S-Corp 2% Medical Plan amounts.
In ADP, the S-Corp 2% Medical Plan amount will not be paid to the employee and therefore will not increase the payroll cash out flow.
Box 1 should include salary amount plus the premium amount.
Boxes 3 and 5 should include only the salary amount.
Box 14 should show something like “S-CORP $30,000.”
If it looks like that, you’re good.
QuickBooks Online supports a built-in “S-Corp Owner’s Health Insurance” pay type, which handles much of the tax reporting automatically.
Refer to the detailed instructions linked here
Doing this wrong can cause headaches and missed deductions.
Get it right once and take the max deductions you are allowed. For additional details, refer to the FAQ below.
We know the whole reporting process is overly complex. You must add your health insurance to your wages just so you can subtract it later. But it’s the only way the IRS lets S-Corp owners claim the deduction.
So while this rule doesn’t make much sense, it’s worth doing right.
If you’re unsure whether your W-2s or payroll setup are correct, we’re happy to review it with you before year-end if you are a client.
If you want to learn more about how we help our high-earning business owners, book a complimentary call below.
What if my health insurance was not paid by my S-Corp?
To be deductible by the S-Corp, the health insurance premiums must be paid by the S-Corp directly or reimbursed to the shareholder who personally paid for the premiums.
What type of health insurance applies?
Medical Insurance
Dental and Vision Insurance paid as premiums
Medicare Part A (if voluntarily paid), Part B, Part C (Advantage), and Part D (prescription drug)
Qualified Long-Term Care Insurance (subject to IRS limits)
What type of health insurance does not apply?
You cannot deduct premiums for any month in which you (or your spouse) were eligible to participate in an employer-subsidized health plan (regardless of whether you accepted it).
Life insurance premiums
Disability income insurance
Worker’s compensation insurance
Supplemental indemnity policies (e.g., Aflac hospital cash plans)
Dental/vision costs not paid as premiums (like braces or glasses)
If the S-Corp pays the shareholder’s health insurance premiums and they are also included in payroll expenses, will the cost be double counted?
Not if it’s recorded correctly. The key is to ensure that the health insurance premiums are only reflected once as a payroll expense. Depending on your payroll provider and chart of accounts setup, the premium may initially post to a health insurance expense account and then be reclassified to payroll expense when included in the shareholder’s W-2 wages. Review your accounting entries to confirm that the expense is not duplicated.
What are other requirements to consider?
Reasonable salary: The shareholder must be paid a reasonable base salary. The health insurance premium amounts shouldn’t be used to “artificially inflate” wages for lack of a proper salary base.
Box 5 / Medicare wages limit for deduction: Even though premiums are excluded from Box 5, the self-employed health insurance deduction is limited to the Medicare wages (Box 5) you earned. If you report too small a base wage, you may not be able to deduct all the premiums.
Timing: Make sure the reimbursements or payments are done within the calendar year so they can be included in that year’s W-2.
Document the plan: The S-corp must “establish” the health insurance plan (e.g. via corporate resolution, plan document, or reimbursement plan) so it qualifies under IRS rules and notices (e.g. Notice 2008-1).
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