If you’re the owner of a small business organized as an S corporation, you’ll want to know about the S corp health insurance deduction. It’s a federal tax deduction that can save you thousands of dollars every year. However, the process can be a bit confusing to the uninitiated. In particular, understanding the rules for 2% shareholders, reimbursements, and W-2 reporting trips many people up. Here’s a plain-English guide to the S corp health insurance deduction. We’ll cover all the rules and steps to help you successfully claim it.
What Is the 2% Shareholder Health Insurance Deduction?
A 2% S corp shareholder is any individual who owns more than 2% of the company’s stock. Such individuals are subject to special rules surrounding the S corp owner health insurance deduction. The business must pay for or reimburse the owner for the cost of a healthcare plan premium and include it on the owner’s W-2 form. The cost qualifies as compensation, so it must be added to the Box 1 total on the W-2.
Payment or Reimbursement of Healthcare Premiums
The S corp health insurance deduction depends on the company paying for premiums directly or reimbursing owners for premiums as compensation. In the latter case, the company must document the owner’s payment before reimbursing them. S corp owners can’t pay for insurance out of pocket and deduct the cost directly. The company must treat the expenditure as a real expense and document it in its books. Doing so becomes part of the necessary paper trail for the S corp owner health insurance deduction. The IRS will look for this documentation during an audit, and owners may become personally liable if they do not have it.
Health Insurance W-2 Reporting Requirements
The IRS requires S corporations to report all directly paid and reimbursed healthcare premiums as taxable income for each owner. That’s why it must appear in Box 1 of owner W-2s. It allows the IRS to validate the S corp health insurance W-2 process followed by the company and compare it with the personal tax filings of its owners. However, the costs aren’t subject to Medicare, Social Security, or unemployment tax withholding like the rest of the owner’s income. Therefore, it should not be part of the totals in Boxes 3 and 5 of the owner’s W-2.
Claiming the S Corp Health Insurance Deduction
Each owner must claim their S corp health insurance deduction when filing their personal taxes. Unfortunately, this is where many grow confused about how to deduct health insurance in an S corp. However, as long as the owner’s W-2 includes the healthcare plan cost in Box 1, the process is straightforward. The owner can claim an above-the-line deduction of the total cost in arriving at adjusted gross income (AGI).
Common Mistakes That Affect Deduction Eligibility
There are a handful of common mistakes that can lead to issues in claiming the S corp health insurance deduction. One is misclassifying the reimbursement as nontaxable income, which makes the owner ineligible for the 2% shareholder health insurance deduction. Another is when the owner pays an insurance premium out of pocket and neglects to seek reimbursement during the tax year. In that case, they cannot claim the deduction at all. Finally, documentation issues at any step in the process can trigger an IRS audit, which may result in penalties for improper procedures.
When to Seek an Accountant’s Help
Generally, an S corp with only a few owners should be able to manage the accounting necessary to generate proper S corp health insurance W-2 entries. However, businesses with several principals should outsource their bookkeeping to a bookkeeping team or a CPA. That can eliminate errors that could prevent owners from claiming the S corp health insurance deduction. It can also ensure there’s a single point of contact for accounting data in the event of an IRS audit.
The Takeaway
As you can now see, claiming a health insurance deduction as an S corp owner isn’t difficult. However, the S corp itself must follow the proper procedure to avoid problems for itself and its owners. Misclassification or incorrect filings can create risks, but they aren’t difficult to avoid with minimal effort.
Get in touch with Aced Accounting and make sure you are not leaving money on the table.
