When it comes to health insurance expenses for certain categories of employees, the tax rules get a little complicated. IRS Notice 2008-1 addresses one of these specific groups: 2-percent shareholders of S corporations. These individuals have unique considerations regarding health insurance costs.
Reporting health insurance premium payments incorrectly can impact both the company and the shareholders’ tax situation. Let’s take a look at the details of this notice, and hopefully shed some light on its provisions, implications, and consequences.
To start, let’s begin with the rule, IRS Notice 2008-1. When an S corporation shareholder owns 2-percent or more of the company, the health insurance premiums that the company pays on his or her behalf must be reported on the shareholder’s W-2. In turn, the S corporation is permitted a deduction for the health and accident insurance premiums it pays for these shareholders and their dependents.
If health insurance premium payments are not reported in this way, the IRS can deny the S corporation the deduction for the payments. This negative consequence impacts both the company and the shareholders’ tax situation, and creates more work for your accounting team.
Who qualifies as a 2-percent shareholder?
Before delving into the specifics of IRS Notice 2008-1, it’s necessary to understand who 2% shareholders are and why they merit distinct tax treatment.
When it comes to employee fringe benefits, the IRS treats a shareholder who owns more than 2% like a partner in a partnership for tax purposes. The meaning of “2% shareholder” is any person who owns more than 2% of the company’s outstanding stock or more than 2% of the S corporation’s total combined voting power on any day during the company’s taxable year.
Are the health insurance premium deductions under Notice 2008-1 given to the shareholder or the corporation?
If the reporting is performed correctly, both the S corporation and the shareholder may deduct these premiums. Let’s start with the S corporation: An S corporation may deduct the health insurance and accident insurance premiums it pays for 2% shareholders, spouses, and their dependents. But to do so, it must report the premiums as wages on the respective shareholder’s W-2. So, in essence the company’s deduction for the shareholder’s health and accident insurance is probably better thought of as non-wage compensation or fringe benefit expense.
The shareholder’s W-2 wages—which includes the health insurance premiums—are reportable on the shareholder’s individual return. And, as a result of the insurance premiums inclusion in the shareholder’s Box 1 taxable wages, the shareholder will be entitled to a self-employed health insurance deduction on Schedule 1, Part II.
What about insurance premiums that the S corporation shareholder pays personally (outside of the company)?
Health insurance premiums paid by the shareholders themselves may also be deducted. To do so, the S corporation and the shareholder must do the following:
- The shareholder must provide proof of the insurance premium payments to his or her S corporation;
- The company must reimburse the shareholder; and
- The company must still report the amount of the premiums as taxable wages (Box 1) on the shareholder’s W-2.
Where to report shareholder health insurance on Form W-2
Premiums reported as wages on a W-2 are not subject to Social Security, Medicare (FICA), or Unemployment (FUTA) taxes. These additions to wages are included in the shareholder-employee’s Box 1 (taxable wages) of Form W-2, Wage and Tax Statement, but are not included in Boxes 3 and 5.
What requirements and conditions need to be met to qualify for the health insurance premium deduction?
- Deductions cannot be taken when they exceed the shareholder’s earned income from the business providing the plan;
- Deductions cannot be taken during a month in which the shareholder has eligibility to participate in any subsidized health plan maintained by another employer or of their spouse; and
- Payments of accident and health insurance premiums by an S corporation on behalf of 2-percent shareholder-employees are not considered distributions when single class of stock requirement is met.
Let’s look at a few scenarios:
Scenario 1: Anthony, a married 2-percent shareholder, and his spouse are covered by a health insurance plan paid for directly by the S corporation. His spouse is eligible for an employer-sponsored plan through her job, but the family gets better coverage through the plan offered by the S corporation. Since Anthony’s spouse has the option to be covered by her employer’s plan, their health insurance premiums are not deductible.
Scenario 2: Shanora is a single, 2-percent shareholder who buys her health insurance through her state’s insurance marketplace. The S corporation later reimbursed her for the total cost of her monthly premiums. Provided all other eligibility criteria are satisfied, Shanora’s premiums are deductible.
Scenario 3: Juan is a 2-percent shareholder, and his S corporation directly pays the health insurance premiums for a plan that covers him and his entire family. However, one of his children has high medical costs, so their premium is $40,000 for the year. For that same year, Juan only earned $35,000 through his work for the S corporation as a 2-percent shareholder. Because his premiums are higher than his earnings, they are not deductible.
What do I do if my W-2s were processed incorrectly?
If you are an S corporation owner and have issued W-2s with errors to yourself or other shareholders, we can help you reissue corrected W-2 forms. Reissuing a W-2 allows you to correct mistakes in the original form, including missing wages related to healthcare premiums that your company paid on behalf of an employee.
Consult a tax professional for IRS Notice 2008-01
Given the intricacies of IRS Notice 2008-1 and its implications for both employers and employees, consulting with a tax professional is highly advisable. Tax advisors can provide tailored guidance based on individual circ*mstances, ensuring compliance with regulations while optimizing tax efficiency.
Is my S corporation eligible for other tax deductions?
Wondering if there are other tax deductions you could take advantage of? Want to learn more about the best small business tax deductions for the self-employed? If so, we have put together a comprehensive guide of small business tax tips and strategies for tracking expenses. It includes detailed examples to help you take advantage of these tax savings.
Download our comprehensive guide: Small Business Tax Deductions—Your guide to understanding the overall impact of business expenses. If you have specific questions about your unique situation, please contact us to schedule a consultation.
