Deducting Health Coverage by Self-Employed Persons and More-Than-2% S Corporation Shareholders

Self-employed persons (sole proprietors, partners, and LLC members), as well as more-than-2% S corporation shareholders, may deduct the cost of health insurance (including long-term care coverage) they receive through their business, but not as a business expense (this rule has not been changed by the Patient Protection and Affordable Care Act). A self-employed person who buys coverage in his or her personal name can deduct the premiums above-the-line (assuming there is sufficient income from the business as explained later). However, a more-than-2% S corporation shareholder can only claim an above-the-line deduction for a policy purchased by the corporation, or the corporation reimburses the shareholder for premiums, and includes this amount on the shareholder’s Form W-2. If the policy is purchased by the shareholder, premiums must be treated as an itemized medical expense (subject to the 7.5% of adjusted gross income floor). This is so even if state law bars a 1-person S corporation from purchasing a policy.

The deduction is taken from gross income on page 1 of Form 1040 (other than for a 1-person S corporation whose shareholder personally buys the policy). This means the deduction is allowed even if the self-employed person does not itemize deductions. The policy can be purchased individually (it need not be purchased by the business).

The deduction cannot exceed the net earnings from the business in which the medical insurance plan is established. You cannot aggregate profits from 2 or more businesses to establish the net earnings ceiling required for deducting health insurance premiums. For S corporation shareholders, the deduction cannot be more than wages from the corporation (if this was the business in which the insurance plan was established).

You cannot take the deduction for any month if you were eligible to participate in any employer subsidized health plan (including your spouse’s) at any time during the month. For example, suppose you are a single, self-employed individual and pay for your own health coverage. On July 1, 2012, you begin a job in which your employer provides you with health insurance. You can deduct the applicable percentage of your health insurance from January 1 through June 30, 2012 (the time you did not receive any subsidized health coverage).

You can include “above the line” your Medicare Part B and Part D premiums. You can add your spouse’s Medicare premiums if your spouse is covered by Medicare.

In calculating self-employment tax, do not reduce net earnings from self-employment by your allowable medical insurance deduction.