If you provide health insurance to employees who own more than 2% in your S Corporation, the premiums are tax deductible for your company and reportable as wages on the shareholder-employee’s Form W-2, subject to income tax withholding. However, these additional wages are not subject to Social Security, Medicare or Unemployment tax. The additional compensation is included in the shareholder-employee’s Box 1 wages on form W-2 but not included in boxes 3 and 5.
The 2-percent shareholder (someone who owns more than 2% of the outstanding stock of the corporation or stock possessing more than 2% of the total combined voting power of all stock of the corporation) is eligible for an above-the-line deduction in arriving at adjusted gross income for amounts paid during the year for medical premiums if the medical care coverage was established by the S Corporation-this means either the S Corporation pays the insurance directly or they reimburse the shareholder for payment and then include the health insurance in the W-2. Note: if the shareholder or the shareholder’s spouse was eligible to participate in any subsidized health care plan, then the shareholder is not entitled to the above-the-line deduction.
For example, if you were to pay $50,000 for wages to the owner/shareholder and not include $5,000 of health insurance premium expense in the wages, the only potential deduction for the individual Form 1040 would be available only if the taxpayer qualified to itemize. Due to limitations, there is no guarantee that the entire expense of $5,000 would be deductible. Conversely, if the owner/shareholder were paid $50,000 plus an additional $5,000 in compensation (or whatever amount the health insurance premiums constituted) and the total amount was included in boxes 1 and 14 on the W-2 form, the shareholder would be eligible to take the entire $5,000 as an adjustment to income above the line. The potential deduction occurs at the S Corporation level and passes thru to the shareholder on the K-1. The increase in wages and the above the line deduction would net out to 0.
To assure that you can take advantage of this deduction, your W-2 needs to show health insurance in boxes 1 and box 14 and the health insurance needs to have been paid by the S Corporation as explained above. If a payroll company prepares your W-2 it is important to notify them that you are a greater than 2% shareholder and provide them with the health insurance amount as soon as possible. Please do not hesitate to contact a member of the Shilts Team with any questions you may have.
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.