Health Insurance for S Corporation Owners

For many years, the tax law has treated more than 2% owners of S Corporations as non-employees with respect to tax-free fringe benefits. The effect has been that the health insurance benefits provided by the S Corporation to its owners are not tax-free fringes, but rather must be reported as compensation on the Form W2 of the owner. The owner then claims the 100% self-employed health insurance deduction to offset the extra W2 income. This all has the effect of allowing a full deduction for the health insurance, although we go through a complicated series of steps involving the 1040 to get that result.

Several years ago, the IRS advanced the position that the health insurance policy for the S corporation owner must be in the name of the S corporation. The IRS asserted that the S Corporation could not simply reimburse the premium costs if the policy was owned by the individual shareholder.

Now, in an important change in position, the IRS has conceded that it makes no difference whether the health policy is personally owned or owned by the S Corporation. In either case, the S Corporation may pay or reimburse the premium, and, therefore, qualify the owner for full deductibility of that premium. We are still required to go through the steps of W2 inclusion and claiming the offsetting deduction. But at least the IRS has dropped its former position regarding the ownership of the health insurance policy. Further, if a shareholder of an S Corporation did not claim the health insurance deduction in the past due to this IRS position, but otherwise had the S Corporation make the premium payment, amended returns may be possible.

Spousal Employment and Health Benefits

Many small businesses are organized as proprietorships (one owner) or partnerships. And it is common in those small businesses that the spouse of an owner may provide part-time or even full-time services to the business. In those cases, by formally employing that spouse, it becomes possible for the business to provide tax deductible health insurance, and, sometimes additionally, a medical reimbursement plan, both of which are tax-free fringe benefits to that spouse-employee.

In our Spring newsletter, we commented on a tax court case that had scrutinized one of these spousal employment arrangements.  That case disallowed the fringe benefits due to the inability of the taxpayer to document that actual services were rendered by the spouse to the business, and that the compensation and fringe benefit package were reasonable in exchange for the value of those services.

Fortunately, a recent tax court case has rebuffed IRS attempts to further narrow the spousal employment opportunity. The case involved a proprietor who employed his spouse for part-time services.  As part of that arrangement, the business deducted several health insurance policies. In one case, the insurance policy was issued in the employee-spouse’s name, whereas another insurance policy was solely in the proprietor’s name. The tax court disagreed with the IRS position that the health policy in the proprietor’s name could not be part of the employee fringe benefit plan. Because the business had paid all of the premiums and did so under an employer-provided health plan arrangement, the proprietorship was allowed to claim all of the premiums as a business expense (Frahm, TC Memo 2007351).

For those small business proprietorships and partnerships that either have spousal employment arrangements or could benefit from these, we can assist in assuring that they are properly structured to qualify for tax deductibility.

If you have any questions concerning the tax issues discussed here, please contact us at info@marg.com.