Health benefits are a vital part of financial planning for business owners, especially those operating under an S Corporation structure. While S Corporations offer tax advantages and operational flexibility, they also come with specific rules regarding what health-related expenses can be deducted. Understanding these rules is essential for maximizing deductions while staying compliant with IRS regulations. This article breaks down what S Corporation owners can and cannot deduct when it comes to health benefits.
Health Benefits and the S Corporation Structure
An S Corporation is a pass-through entity, meaning its profits and losses flow directly to shareholders and are reported on their personal tax returns. Shareholder-employees—those who own more than 2% of the company and also work in it—are treated differently than regular employees when it comes to health benefits. The IRS has special rules for these individuals, which affect how premiums and reimbursements are taxed and deducted.
What You Can Deduct as an S Corporation
Health Insurance Premiums for Shareholder-Employees
If the S Corporation pays for health insurance premiums for a shareholder-employee who owns more than 2% of the company, the premiums must be included in the employee’s W-2 as taxable income. However, the shareholder may still be able to deduct the premiums on their personal tax return under IRC Section 162(l), provided certain conditions are met.
To qualify for the deduction:
- The insurance plan must be established by the S Corporation
- The shareholder must report the premiums as wages on their W-2
- The shareholder must not be eligible for coverage under another employer-sponsored plan (e.g., through a spouse)
When these conditions are satisfied, the shareholder can deduct the premiums as an “above-the-line” deduction, reducing their adjusted gross income.
Health Reimbursement Arrangements (HRAs)
HRAs allow employers to reimburse employees for medical expenses and insurance premiums. For S Corporations, HRAs can be used for non-shareholder employees, but they are generally not available to more-than-2% shareholders. Attempting to reimburse a shareholder through an HRA may result in disallowed deductions and tax penalties.
Qualified Small Employer Health Reimbursement Arrangement (QSEHRA)
QSEHRAs are designed for small businesses that do not offer group health plans. While they can be used to reimburse employees for premiums and medical expenses, they are not available to more-than-2% shareholders. Only non-shareholder employees can benefit from QSEHRAs under current IRS rules.
Dental and Vision Insurance
Premiums for dental and vision insurance are treated similarly to health insurance. If paid by the S Corporation for a more-than-2% shareholder, they must be included in the shareholder’s W-2 income. The shareholder may then deduct them on their personal return if the plan is properly established and other conditions are met.
What You Can’t Deduct
Premiums Not Properly Reported
If the S Corporation pays health insurance premiums but fails to include them in the shareholder’s W-2, the deduction may be disallowed. Proper reporting is essential to qualify for the personal deduction.
Coverage for Non-Qualified Individuals
Health benefits provided to individuals who are not employees or shareholders—such as contractors or family members not on payroll—are generally not deductible. The IRS requires that health benefits be tied to employment status and properly documented.
Reimbursements Without a Formal Plan
Reimbursing medical expenses informally, without a written plan or proper documentation, can lead to disallowed deductions. All reimbursements must be part of a formal arrangement and comply with IRS guidelines.
Conclusion
Navigating health benefits within an S Corporation requires attention to detail and a clear understanding of IRS rules. While shareholder-employees can deduct health insurance premiums under certain conditions, improper reporting or informal arrangements can jeopardize those deductions. By establishing formal plans, documenting expenses, and working with a qualified tax advisor, S Corporation owners can optimize their health benefit strategy while remaining compliant.
