Typically, the cost of health insurance premiums paid by a business is excluded from an employee’s taxable income on their W-2. But those owning at least 2 percent of the stock of an S Corporation – classified by the I.R.S. as “2 percent S Corp Shareholders” – will not be eligible for this exclusion. With the right Small Business Accounting services, however, you can find another way to deduct the cost of premiums.
First, let us start with the basics. An S Corporation (short for Subchapter S Corporation) is what is known as a “pass through tax entity”, meaning it passes corporate income, credits, losses, and deductions through to their shareholders for federal tax purposes. This helps shareholders avoid double taxation at the corporate level, since this flow through income and loss is reported on their personal tax returns, and they are assessed at their individual income tax rates.
An S Corporation is also classified as a “closely held” business entity, in that the spouse, children, parents, or grandparents of a shareholder are treated as also owning the shareholder’s stock – in a sense, they are indirect shareholders. Anyone owning 2 percent or more of the S Corporation’s stock directly or indirectly, at any time during the tax year, is seen by the I.R.S. as a 2 percent S Corp shareholder.
The cost of health insurance for a 2 percent shareholder paid by the S Corp. is included in the shareholder’s W-2 as taxable income and is subject to federal income tax. If the premiums were paid under a plan for most employees – characterized by a reference in the employment contract, contributions made by employees, support through a separate fund, and so on – it will not be subject to FICA or FUTA taxes (which fund Social Security and Medicare, and unemployment, respectively).
Here’s where health premium deductions come in. The S Corp. can deduct healthcare premium costs for 2 percent shareholders on Form 1120S, the U.S. income tax return for S Corporations. The premiums can be treated as additional compensation to the shareholders, allowing for deductions to be made that pass through to all shareholders proportionately.
A 2 percent shareholder can deduct the entire cost of the health insurance premium paid by the S Corp – and included in their W-2 – on their personal tax return (Form 1040). The only limitations are:
- The deduction cannot apply to periods when the 2 percent shareholder (or their spouse) is eligible for another employer-provided health insurance plan
- The deduction cannot be greater than the taxpayer’s earned income derived from the activities of the business providing the health insurance plan.
Needless to say, sorting all of these details out for yourself can be arduous and time-consuming. As a business owner or shareholder, your time and money are best spent on other aspects of your enterprise. Leave these details to Quilca CPA Group. We specialize in all aspects of Small Business Accounting, from tax compliance to finding and managing the right business entity. Contact [email protected] or (786) 310-5582 to learn more.
