If you have chosen an S Corporation as your business structure with your business partners, it's undeniable that it has incredible tax advantages. A few of the benefits of an S Corp you get are not having to pay corporate taxes and lower taxes on social security and Medicare. In fact, you are also taxed right after the profit allocation among corporation shareholders.
Although, with all these advantages, health insurance for every member of S Corporation can be complicated to understand.
As most people say, health insurance plays a crucial role in providing financial security and access to quality healthcare.
Furthermore, S Corp employees can claim tax-free health insurance, but if you are also a shareholder who only owns more than 2% of the company stock, you cannot have the same benefits as them.
This is where things about health insurance get complex!
As an S Corporation owner, understanding the strategic approaches to health insurance is essential to maximizing benefits and navigating tax implications.
In this article, we have written important considerations for you as an S Corporation owner regarding health insurance deductions, S Corp payment of premiums, health reimbursement arrangements (HRAs), fringe benefits, and personal income tax deductions.
Importance of health insurance for S Corporation owners
Health insurance is a critical aspect of financial planning and risk management for individuals and businesses alike.
For S Corporations, whether employees or owners, the significance of health insurance goes beyond personal well-being. It directly impacts business operations, tax planning, and overall financial stability.
Additionally, health insurance provides S Corporation owners and employees with vital protection for themselves and their families.
Health Insurance Employee Benefit for an S Corporation
The law is complex when it comes to health insurance premiums. This could be one of the drawbacks of being an S Corp because employees or owners cannot deduct the cost of insurance from taxes.
As part of running an S Corporation, it is necessary to provide health insurance benefits to employees, as their benefit is part of the business.
The specifics of how accident and health insurance premium payments for flow-through tax entities should be made are governed by IRS Notice 2008-1, titled "Special Rules for Health Insurance Costs of 2-Percent Shareholder-Employees."
If an employee is also a shareholder, holding more than 2% or more of the company stock, then the cost of health insurance is expected to be included in the employee's taxes as income.
This suggests that, as a shareholder and employee, you must pay income tax on the premiums together with Medicare and Social Security taxes on that amount. But keep in mind that employing a spouse.
Can an S Corp owner deduct health insurance?
As an S Corp owner, you can deduct the cost of your health insurance in certain circumstances. There are, however, requirements and restrictions to be aware of. You must typically be regarded as an S Corporation employee in order to be eligible for the deduction and adhere to strict IRS guidelines.
In fact, self-employed owners can deduct self-insurance premiums for themselves and their dependents.
If the health insurance plan is regarded as having been established by the business and not by you, you may directly deduct this on Form 1040, Line 29, Self-Employed Health Insurance Deduction.
To determine whether the health insurance policy is established by the business, the IRS considers:
Who pays policy premiums?
How the health insurance premiums reported for income tax purposes by both the company and the S Corp owner
To be eligible for this deduction, a shareholder must have paid premiums. Additionally, there are exceptions to the 2% shareholder offset rule:
The deduction must be less than the shareholder's income from that S Corporation.
The shareholder cannot take the deduction if they are able to participate in another health plan from an employer (or even a spouse’s employer).
Can an S Corp pay for the owner's health insurance?
Yes, but only if done in accordance with IRS regulations. The owner-employees health insurance premiums can be paid by the S Corporation on their behalf, and it can be a part of their remuneration.
How is health Insurance shown in W2 for an S Corp owner?
Health insurance premiums are reported on Form W-2 in Box 1 (wages subject to federal withholding) and Box 14 (other information), but they are not included in Box 3 or Box 5 (wages subject to Social Security and Medicare).
The same rule applies to health insurance paid on behalf of family members (such as parents, spouses, children, or grandchildren) who work for your S Corporation, even if they are not shareholders. The premiums paid on their behalf must be included in their wages on Form W-2 in Box 1 and Box 14.
How health insurance is shown in books?
Instead of being classified as health insurance in the company's books, medical premiums should be reported on the shareholder's W2 as compensation.
Make a journal entry for S Corp medical expenses and reconcile the book wage expense with the W3 form to accurately keep track of these costs. Transparency can be preserved by using the expense sub-ledger "officer compensation - S Corp Medical".
Furthermore, you would have to increase the officer compensation-S Corp medical expense in the journal entry and decrease the account used to pay the shareholder and other employees' medical premiums annually in the journal entry.
This is to avoid adding the cost of health insurance and wages for the same premiums twice.
By the end of the year, or in pro-rata amounts each pay period, this expense should be processed through payroll to ensure proper reporting and that it shows up correctly on the W2.
The credit can be recorded as cash if the shareholder receives a reimbursement check, or it can be used to reduce shareholder distributions if the shareholder paid for the medical expenses out of their own pocket, in which case the account to debit would once again be "Officer Compensation - S Corp Medical".
However, it's important to maintain equitable pro rata distributions for each shareholder and to handle the money through payroll.
Health Reimbursement Arrangements (HRAs) and S Corp Owners
HRAs, or Health Reimbursement Arrangements, are known to be tax-free employee fringe benefits.
S Corps avoid paying taxes on their profits and losses by passing them through the personal income tax returns of their shareholders.
An S Corp owner who owns more than 2% of the business is regarded as a self-employed person and not an employee because of this arrangement, so you are usually not eligible to take advantage of an HRA.
HRAs have specific rules and guidelines, such as that only W-2 employees are eligible for HRAs, and since S Corp owners and their families are taxed as shareholders rather than as employees, they are not treated as such.
As a result, if you are an S Corp owner, you are prohibited from taking part in an HRA.
Nonetheless, as an S Corp owner, you are still permitted to give non-owner employees an HRA. HRAs give you total control over your budget while allowing employees to decide how to use their healthcare reimbursement.
Fringe Benefits and their impact on S Corp Owners
Fringe benefits can include various perks such as health club memberships, group term life insurance, and cafeteria plans.
These benefits can have tax implications for both the S Corporation and the owner-employee.
The cost of your employees' medical expenses can be covered by taxable fringe benefits if you are the owner of an S Corp. In fact, as long as you count it as additional income, you can also join the stipend benefit.
Be aware that taxable fringe benefits must be reported as taxable income in order to qualify for a deduction as additional wages and salaries on Form 1120S.
Lastly, it is crucial to understand the specific rules and limitations associated with each fringe benefit and properly document their provision to ensure compliance with IRS regulations.
To maximize benefits and navigate tax complexities, As an S Corp owner must take a strategic approach to health insurance.
In order to make well-informed choices to safeguard your health and financial security, it is best to understand the laws and rules governing health insurance deductions, S Corp payment options, HRAs, fringe benefits, and personal income tax deductions.
Consulting with tax professionals and staying updated on changes in regulations is key to ensuring compliance and maximizing the advantages of your health insurance.
Compass CPA PC is committed to assisting clients with their health insurance needs. If you require guidance or support in navigating health insurance matters, we are here to help.
Our team of professional tax specialists has extensive experience in handling various tax cases, ensuring that you are in capable hands.
Schedule a call with Compass CPA PC if you need assistance deciding how to distribute premiums or additional compensation. We can assist you in following IRS regulations so that your shareholders are satisfied.