Health Insurance and Our S Corporation

Health insurance is a benefit that most companies offer. It is a great way to attract and keep good employees, and it provides some tax benefits as well. Even the share of the premiums that the employee pays can be treated as a pre-tax deduction and save the employee and the company significant money. What becomes a little more complicated is if you are the owner of an S Corporation and you participate in the health insurance program.

IRS regulations require that you report the company paid portion of health insurance as compensation for anyone who owns more than 2% of the company stock. This is the case for more than 99% of owners of S Corporations. Massachusetts also follows this rule.

Here is an example: Suppose your salary is $50,000 and you also paid $10,000 for your health insurance. (I know, you wish it were only $10,000.) Your W-2 should show federal taxable wages of $60,000. It also should show this amount as state wages in Massachusetts and probably others states as well. The Social Security and Medicare wages should only be $50,000. This add back to your income is not subject to Social Security or Medicare taxes.

You might be about to panic because you think you will be paying more in income taxes because of this adjustment. I have good news. It is true that you will report $60,000 on line 7 of your personal tax return. But you will get to deduct the $10,000 on line 29 of your return and thus pay tax only on the $50,000 of salary.

If it does not have any impact, why do it? Reason one: The IRS requires it. Why challenge them? Reason two: If you do not put the health insurance on your W-2, you will have to report it as income anyway and then you can deduct it as a medical expense on Schedule A of your return. Medical expenses are subject to a 7.5% of income floor and you may lose some or all of the deduction. It could cost as much as 40% of the cost of the health insurance in additional taxes. Now that’s a great reason to do it.

I’d be happy to talk with anyone who has any questions about this.