It’s not that hard to figure out what the IRS is going to do next. For one thing, they tell us tax pros every year where they are going to focus their attention. But, if you’re paying attention you can figure it out a year or more in advance and that gives you time to prepare.
One of the areas that we’ll see a lot more audits in is S Corporations. And one of the problems areas is going to be medical insurance deductibility.
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 2009 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 2009.
If you’ve already issued the W-2s (which you should have) you can create amended ones to correct the medical insurance issue.
If you’ve got an S Corporation, the IRS has its eye on you. And that means an audit. If the audits are anything like the brutal audit teams that have targeted Real Estate Professionals then we can expect some bad times ahead for S Corporations.
Be prepared! Our March 23rd USTaxAid coaching session http://www.usataxaid.com/coaching is focusing on Filing Your S Corporation tax return – safely and with the most legal tax deductions you can take.
Tags: Business • Business deductions • Business Structure • Business Structures • choice of entity • limited liability company • LLC • LLC-S • s corp • S Corporation • small business • Tax • Tax deductions • Tax strategies • Tax Strategy • taxes
Related posts:
- Little Known Trick to Turn a 50% Meal Deduction Into 100% Deduction
- The Importance of S Corp Basis
- How to Get a Tax Deduction for Your Golf Cart
- S Corp Salary Mistake Costs Thousands of Dollars
- RIP S Corporations?
On February 26th, 2010 | 5:18 am
Marsha said:
Hi Diane. First - I am a big fan of yours and have many of your books! But I have a question to confirm the way I am handling my HRA for tax purposes.
I am a >2% s-corporation shareholder. Many years ago I established a Health Reimbursement Arrangement (HRA) for our company (I used 105Concepts to establish and maintain every year and it has non-discrimination rules and other ERISA & HIPPA language.) Can you confirm that not just premium but also non-premium medical expenses can be deducted above the line when reimbursed from an HRA to a >2% s-corporation shareholder? By non-premium I mean out-of-pocket expenses. I am using this logic to currently deduct the out-of-pocket expenses right now:
1. The first is IRC Section 105. This is the code section that establishes the HRAs as a self-funded group insurance plan. Section 105(e) provides that amounts received under an accident or health plan will be treated as amounts received through accident or health insurance.
2. The Self-Employed Health Insurance deduction is allowed under IRC Section 162(l) and allows a deduction for the amount paid during the taxable year for insurance which constitutes medical care.
3. So I believe I can take the entire amount because the HRA is the insurance plan that is applicable for the deduction.
4. Note I think any other insurance plan “inside” the HRA is re-insurance to cover excessive loss and just another cost of providing the self-funded group insurance plan. I think I could have no other insurance plan at all and just have my S Corp reimburse myself for my medical expenses. That would still be deductible because it’s the HRA that’s the plan for purposes of the self-employed health care deduction.
5. I DO include the payments as part of my W-2 income. Then I deduct it under the self-employed health care premiums, line 29 on my 1040.
6. Other notes: The HRA is in the name of the Corporation. I, as an employee, am enrolled in the plan. Also, the HRA is funded completely by the employer. The employee (me) is not allowed to make contributions to an HRA. As a >2% shareholder the HRA reimbursements are included in my wages (Box 1 of my W2) but they are exempt from payroll taxes, FICA & unemployment. They are subject to income tax withholding.The S-Corp medical payments are also reported in box 14 of my W2 which are then deducted on my 1040 as self-employed medical expenses. The net result is the company pays the out-of-pocket medical expenses with no tax implication to me.
7. Last note: Core Documents (another HRA plan provider) outlines exactly what I am doing on their web site and say this: The S corporation should establish or sponsor a Section 105 Health Reimbursement Arrangement or HRA plan document to reimburse individual health insurance premium to the S corporation sole shareholder/ employee. This satisfies the IRS Headliner 163 requirement for a group plan. An added bonus of the Section 105 HRA is the ability to also reimburse out-of-pocket medical expenses tax-free.
Thank you in advance, Diane, for letting me know if I am doing this right. If I am doing it wrong I need to know that right away!
On February 28th, 2010 | 7:42 pm
Diane Kennedy said:
The IRS is pretty clear that a greater than 2% shareholder does not have the same benefits available that a regular employee does.
My concern as I read your details is it looks like you’re mixing the two a bit. The benefits will be exempt from Social Security & Medicare, but are not deductible for income tax purposes, but the time you’ve done the proper reporting on your W-2.
But I might be incorrectly reading what you’re doing. My suggestion is to contact your plan administrator and lay out exactly what you are doing. If they say it’s okay, then their name, reputation and E & O insurance is on the line. You should also check in with your CPA to make sure your W-2 is being properly prepared.
On March 1st, 2010 | 1:17 pm
Liz said:
Hi, Diane.
I have done some calculations and cannot figure out what the benefit is to the IRS in having >2% shareholders report health insurance this way. If it’s on the W2 as Box 1 wages but not in Boxes 3 & 5 and an above-the-line deduction for AGI on the 1040, doesn’t it have the same net tax effect as being deducted on the S corp’s P&L?
The only thing I can think of is when, years ago, less than 100% of self-employed health insurance was deductible to an individual, and so it would be a tax benefit for the corporation to deduct 100% on the P&L instead of the 60/70/80/90% allowed by the individual each year until it became 100%.
Just wondering your thoughts.
Thanks!
On March 1st, 2010 | 2:10 pm
Diane Kennedy said:
Liz, your comment is logical. Unfortunately, tax law doesn’t always follow logic.
My guess (and it’s only a guess) is that we’ve gotten here through a series of rule changes. There was a time a few years ago when we all had our hearts stop for a moment when the IRS said that med insurance had to be in the name of the corp in order to be deductible. That left hundreds of thousands of solopreneurs out in the cold. In fact, the IRS said we had to report the benefit if it was paid by the S Corp on the W-2.
So in effect it became a taxable benefit to the owner, ie no tax benefit.
Then, after a lot of complaints, the deduction came back. But instead of taking it as an S Corp deduction, they’ve done it this circuitous way.
I think they’re tracking how many people actually take the deduction for purposes of stats.