348 / How is health insurance coverage taxed for S corporation shareholders?

The IRS issued guidance late in 2014 indicating that accident and health insurance premiums paid to insure a greater than 2-percent S corporation shareholder are treated as wages by the shareholder and are deductible by the S corporation. However, these benefits are not subject to FICA, FUTA or Social Security taxes. The S corporation shareholder is entitled to an above-the-line deduction for amounts paid throughout the year for medical premiums, but only if neither the shareholder nor his or her spouse are otherwise eligible to participate in any subsidized health care plan offered by another employer. The IRS released a CCM clarifying that this remains the case even if the 2-percent shareholder-employee is treated as a 2-percent shareholder via the family attribution rules.¹

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Planning Point: The IRS has released a set of frequently asked questions based upon the regulations governing the Section 199A deduction for pass-through entities, such as S corporations. The FAQ provides that health insurance premiums paid by the S corporation for a greater-than-2-percent shareholder reduce qualified business income (QBI) at the entity level (by reducing the ordinary income used to calculate QBI). Similarly, when a self-employed individual takes a deduction for health insurance attributable to the trade or business, this will be a deduction in determining QBI and can reduce QBI at the entity and individual levels.²

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Unlike in traditional employment situations, the IRS has also noted that if the S corporation shareholder is the sole shareholder, he or she may purchase the insurance in his or her own name, but allow the S corporation to either directly pay for the premiums or reimburse the sole shareholder for those premiums, and still be entitled to the above-the-line deduction for premiums paid. In either case, the premium payment must be reported on the shareholder’s W-2 as wages.³

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Planning Point: Employers now have the option of using a QSEHRA or ICHRA to reimburse employees for individual health insurance premiums without incurring potentially substantial penalties under the ACA.

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With respect to coverage purchased by an S corporation for employees not owning any stock and for shareholder-employees owning 2 percent or less of the outstanding stock or voting power, the same rules apply as in any other employer-employee situation ( Q 8789).