How To Deduct Your Health Insurance as a 2% Shareholder

As a business owner, you want to ensure that you (and your family) have access to high-quality health care—and, as the business owner, that often means shopping for a health insurance plan yourself.

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But if your business is structured as an S-corporation and, under the internal revenue code, you’re considered a 2 percent shareholder, there are certain rules and regulations around how you need to pay and report your health care premiums. As a taxpayer, it’s important to understand those rules and regulations if you want to be able to deduct those premiums on your taxes.

So, what are the rules around 2 percent shareholder health insurance? How does it impact your income tax and wages? And how can you ensure you’re paying for and reporting your premiums correctly so you don’t run into any potential issues come tax time?

What Is A 2% S Corporation Shareholder?

First things first—before we jump into the ins and outs of 2 percent shareholder health insurance, let’s quickly cover what, exactly, a 2 percent shareholder is.

IRS Notice 2008-1, which outlines all the rules and regulations under which a 2 percent shareholder-employee in an S-corp can deduct accident insurance premiums and health insurance premiums, defines a 2-percent shareholder as “any person who owns (or is considered as owning within the meaning of § 318) on any day during the taxable year of the S corporation more than 2 percent of the outstanding stock of such corporation or stock possessing more than 2 percent of the total combined voting power of all stock of such corporation.”

So, as long as you own at least 2 percent of your S corporation at any point during the year (which, as a business owner, is highly likely), in the eyes of the IRS, you’re considered a 2 percent shareholder-employee.

What Are the Rules Around 2% S-Corp Shareholders and Health Benefits?

Now that you understand what a 2 percent shareholder is, let’s jump into the rules around 2 percent shareholders and fringe benefits—and, more specifically, health insurance.

Under IRS Notice 2008-1, premium payments for accident insurance or health insurance plans for 2 percent shareholders are, for income tax purposes, to be treated as shareholder compensation.  As long as health insurance premiums are paid and reported correctly, 2 percent shareholders can take a line deduction for their health insurance plan on Form 1040—the Self-Employed Health Insurance Deduction.

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In summary, if your company pays for health insurance, you have to count that as income on your W-2, but it CAN be deducted on Form 1040. Sounds pretty straightforward, right? Well, there are a few things to keep in mind to ensure that you qualify for the deduction:

The Health Insurance Plan Is Established by the S-Corporation

According to the IRS, “a 2-percent shareholder-employee in an S corporation, who otherwise meets the requirements of section 162(l), is eligible for the deduction under section 162(l) if the plan providing medical care coverage for the 2-percent shareholder-employee is established by the S corporation.”

The question is—what, exactly, do they mean by “established by the S corporation?”

Being established by the S-corporation is less about the health insurance policy being under the business’ name—and more about how the premiums are paid (and who pays them).

In order to qualify for the health insurance deduction, the S corp must make premium payments directly to the insurance company—or, if the shareholder pays their medical insurance premiums, the S corp must provide reimbursement. Just make sure to keep accurate payment and reimbursement records if you’re paying your insurance premiums directly and having your S corp reimburse you.

If the premiums aren’t either paid by the S corp or reimbursed from the S corp to the 2 percent shareholder—or, in other words, if the shareholder pays for their health benefits out of their personal income and does not get reimbursed by the S corporation—the shareholder will NOT qualify for the deduction on their income tax return.

Premiums Must Be Included on the Shareholder’s W-2

As mentioned, for income tax withholding purposes, accident and health insurance premiums need to be treated as shareholder compensation—which means that premiums for the shareholder’s health benefits need to be included as wages on the shareholder’s form W-2. 

Now, an important thing to note is that premiums are included on the shareholder’s W-2 strictly for income tax withholding tax purposes; those additional wages are not subject to FICA taxes (Social Security and Medicare taxes) or Federal Unemployment Tax Act (FUTA).

Bottom line? If health insurance premiums are excluded from the shareholder’s taxable income and are not included as additional compensation/wages on form W-2, the shareholder’s premiums will not be considered deductible for that tax year.

The Health Insurance Plan Qualifies for the Deduction

It’s also important to understand what kind of insurance premiums would fall under the “health insurance” umbrella. Eligible premiums include medical, dental, and vision premiums as well as long term care coverage and HSA contributions.

How to Report Health Insurance Premiums for 2% Shareholders on Tax Forms

How you pay your insurance premiums plays a huge role in whether you, as a 2 percent S-corp shareholder, can claim the health insurance line deduction on form 1040—but so is how you report those premiums to the IRS. Because insurance premiums are treated as compensation for income tax purposes, you have to report them on certain forms (and certain lines within those forms)—but because they’re not subject to FICA and FUTA taxes, you don’t include those premiums in wages on other lines and forms.

For reference, here is where to include—and not to include— insurance premiums on your tax forms:

Form W-2, Wage and Tax Statement

Include health insurance premiums:

• Box 1 (Wages, tips, and other compensation)
  

Do not include health insurance premiums:

• Box 3 (Social security wages)
• Box 5 (Medicare wages and tips)
  

Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return

Include health insurance premiums:

• Box 3 (Total payments to all employees)
• Box 4 (Payments exempt from FUTA tax)
  

Form 941, Employer’s Quarterly Federal Tax Return

Include health insurance premiums:

• Box 2 (Wages, tips, and other compensation)
  

Do not include health insurance premiums:

• Box 5a (Taxable social security wages)
• Box 5c (Taxable Medicare wages and tips)
  

Let Hourly Manage the 2% Shareholder Health Insurance Process for You

If all this seems overwhelming, don’t worry! With Hourly, all you have to let us know is that you qualify as a 2 percent s-corp shareholder—and our payroll software will handle the rest. No worrying about withholding or reporting—and when tax time comes, you’ll be all set to report your premiums correctly and take your line deduction.