If you are self-employed you are allowed to deduct 100% of the cost of health insurance premiums. This includes medical expenses for dental and long term care. It does not matter which business structure you choose – sole proprietorship, s corporation, partnership or c corporation, you are entitled to take this deduction. The deduction is also available to you whether you pay your health care expenses as an individual or through your business.
However, you are not allowed to deduct more than you earn from your business. This means in years you make a loss there is no deduction. You are also not allowed the deduction if you or your spouse are offered a subsidized health care plan through another employer.
Health care deduction for various entities
C Corporation
If your business is a c corporation, you are considered an employee of your business. This entitles you to a full menu of tax-free employee fringe benefits. The corporation will purchase health insurance on your behalf and deduct the health insurance premium. As a c corporation, the premiums are not added to your wages. This makes your health insurance tax free to you.
In corporations, the deductions happen on the corporate level and not personal level but since you own the corporation you still get the benefit.
S Corporation
For S Corporations, the IRS looks at percentage of shares owned. If you own more than 2% of your company’s shares, you can deduct your health insurance premiums. The S Corporation can purchase the health insurance policy for you. The S Corporation will have to report this amount as wages to you. However, health insurance premiums paid on behalf of shareholders are not subject to social security, medicare or unemployment taxes. In other words the compensation is included in Box 1 of the W-2 not Box 3 or 5. A medical plan is established by the S Corporation if either of the following conditions are met:
- The s corporation makes the premium payment
- The shareholder employee is reimbursed for the premium paid and the wages are included in the w-2
On the personal side, the 2% shareholder employee can deduct the health insurance premiums before arriving at adjusted gross income (AGI). For this to happen the s corporation has to pay the insurance premiums either directly or through reimbursement and include it in the shareholders wages. You cannot take the deduction if you or your spouse are eligible for subsidized employer health care plan.
Sole proprietor
As a sole proprietor you are allowed to deduct your health insurance premiums for your, your spouse and dependent children under 27. The deduction is made on your 1040 before determining adjusted gross income (AGI). However, you cannot deduct premiums that exceed your net self-employment income and you cannot deduct premium if you or your spouse are eligible for a subsidized employer plan.
Partnership
If you are a partner in a partnership, the policy can be in your name or the name of the partnership. You can choose to pay the premiums yourself or have the partnership pay them. If you pay the premiums yourself, the partnership should reimburse you for the payments. The premium payments are reported on Schedule K-1 (Form 1065) as guaranteed payments and included in your gross income. If the wages are not reported as guaranteed payment, the insurance plan will not be considered established under the business.
Individual
If you do not own your business you can still deduct health insurance premiums. You can deduct health insurance premiums and out of pocket medical expenses.
You get a lesser deduction than a business owner because you can only deduct medical expenses if it exceeds 10% of your adjusted gross income or 7.5% if you or your spouse are 65 or older. Moreover, if you do not itemize, you cannot take the deduction. The 7.5% limitation is temporary for taxpayers older than 65. The provision expires December 31, 2016.
In summary, the cost of health care can be prohibitive, but using tax breaks to lessen the impact can help leave more money in your pocket. Be sure to consult with your CPA on tax strategies to purchase big ticket items like health insurance.