Three Tests That Decide Your Self-Employed Health Insurance Deduction

The self-employed health insurance deduction is one of the most valuable adjustments available to you. It reduces adjusted gross income dollar for dollar; you get it whether or not you itemize, and the lower adjusted gross income can preserve other benefits that phase out as income rises.

The deduction can cover medical, dental, and vision insurance, as well as qualified long-term care insurance, for you, your spouse, and your dependents. It can also cover your child who was under age 27 at the end of the tax year, even if that child was not your dependent.

It is also one of the easiest deductions to lose. Three tests determine whether your premiums count.

Test One: Was the Plan Established Under Your Business?

If you are a sole proprietor or farmer, you have flexibility. The policy can be in the name of the business or in your own name. An individual marketplace policy purchased personally can still qualify.

Partners also have flexibility, but there is an important catch. If the partnership pays the premiums for a policy in the partner’s name, the amounts generally must be reported as guaranteed payments. If the partner pays the premiums personally, the partnership must reimburse the partner and properly report the amounts. Otherwise, the plan is not considered established under the business.

If you are an S corporation shareholder who owns more than 2 percent, the policy can be in the name of the corporation or the shareholder, but the premiums must run through payroll. The corporation must pay or reimburse the premiums and report them as wages in box 1 of your Form W-2.

Key point:
Pay the premiums personally and skip that step, and the self-employed health insurance deduction disappears.

Test Two: Were You Eligible for Subsidized Employer Coverage?

You lose the deduction for any month you were eligible to participate in a subsidized plan maintained by an employer—yours, your spouse’s, or that of a dependent or a child under age 27.

Eligibility alone is the disqualifier. Actual enrollment does not matter. If your spouse declines employer coverage in favor of your policy, those months are gone.

This test is applied month by month. If you change jobs during the year and become eligible for subsidized employer coverage partway through the year, you do not necessarily lose the deduction for the entire year.

Test Three: Is It Medical Care Insurance?

A policy that carries the word “insurance” does not automatically qualify as medical care insurance.

Disability income coverage, accidental death and dismemberment policies, and fixed-benefit hospital indemnity plans generally do not qualify.

The same issue can arise with school athletic policies, many of which are fixed-benefit accident policies rather than medical care insurance. The policy must also satisfy the separate requirement that it be established under your business.

The Deduction Has a Ceiling

Even if your premiums pass all three tests, the deduction cannot exceed your net earnings from the specific business under which the plan was established.

If you have two businesses and two health plans, you generally cannot use the profit from one business to absorb premiums attributable to the other. A business operating at a loss supports no self-employed health insurance deduction.

Taxpayers with marketplace coverage face an additional complication because the deduction and the premium tax credit can affect each other. The deduction can affect adjusted gross income, which can affect the premium tax credit and, in turn, the amount of the insurance premium actually paid. Special IRS rules address this calculation.

Key Point:
The rules differ depending on your business structure. Sole proprietors and partners generally have flexibility regarding whose name appears on the policy, while S corporation shareholders who own more than 2 percent must properly run the premiums through the corporation’s payroll and report them as wages on Form W-2. Missing that payroll step can cause the deduction to disappear.

Takeaways

• Know how your business structure affects the deduction. The rules for sole proprietors, partners, and S corporation shareholders are not the same.
• Watch for other employer coverage. Eligibility for subsidized coverage through your employer, your spouse’s employer, a dependent’s employer, or an employer of your child under age 27 can eliminate the deduction for the affected months.
• Make sure the policy qualifies. Disability income, accidental death and dismemberment, and fixed-benefit hospital indemnity coverage generally are not medical care insurance for purposes of this deduction.
• Check the income limitation. Your deduction cannot exceed your net earnings from the specific business under which the plan was established.
• Don’t assume a missed deduction is necessarily lost forever. Depending on your circumstances, premiums that cannot be claimed as a self-employed health insurance deduction may potentially be considered as medical expenses on Schedule A if you itemize, subject to applicable limitations.

Next Steps

The self-employed health insurance deduction can be valuable, but small mistakes in how a policy is established or premiums are reported can cost you the deduction. If you are self-employed, a partner, or an S corporation shareholder, I can help you determine whether your health insurance premiums qualify and how the deduction applies to your situation.

If you want to discuss the self-employed health insurance deduction or have questions about your specific circumstances, please contact TrueBlaze.