By forming an S corporation, self-employed individuals can deduct health insurance premiums, but you must include the amount of your premium in your W2 as compensation, though that compensation is not subject to payroll taxes. Although the amount of the premium is subject to income tax, you can deduct it from your personal income taxes, so it’s a wash, explains CPA Steve Petosa of Averett Warmus Durkee.
If your insurance premiums are, say, $5,000, your business is able to take a $5,000 tax deduction; that same $5,000 must be reported as compensation to you, but you get to claim a $5,000 tax deduction on your individual return.
But you should know there are a few catches.
You have to take a salary that is equivalent to what you’d otherwise earn if you took a full-time job, adds attorney Stephen Fishman, author of “Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants.” Internal Revenue Service (IRS) has been challenging S corporations that try to get around paying full Social Security taxes using unreasonably low or no compensation, warns Mark Misselbeck, a CPA with Levine Katz Nannis & Solomon. Plus, Fishman adds, there’s a laundry list of fees associated with an S corporation that can surpass $1,000 per year.
Then there’s the IRS Section 105 plan. You can put your spouse on the business payroll, and as part of his/her compensation package, you can provide your spouse with family health insurance and pay all out-of-pocket medical expenses as an employee benefit that’s fully deductible to your business, says Eva Rosenberg, an enrolled agent better known as the TaxMama. This reduces your self-employment taxes and gets you a full business deduction for medical expenses, she explains.
Say your health insurance premiums are $1,000 per month, and one of your children needs a special school for autism (with a doctor’s prescription) that costs $5,000, and another of your children needs braces at $4,000 and your spouse is diabetic with $1,000 in medication expenses. Through the IRS Section 105 plan, you would reduce your business profits by $22,000, which reduces your self-employment taxes roughly $3,300. If you are in the 25 percent tax bracket, this strategy reduces federal income taxes by $5,500, Rosenberg says. (Conversely, if you were to take a deduction for the health insurance on the first page of your standard tax return, you would save only $3,000.)
You also may deduct premiums for up to $50,000 for term life insurance using the IRD Section 105 plan.