S-Corp Health Insurance

[Taxman]

I have a new client (law firm) which is an S - Corp owned 100% by a single shareholder. The shareholder works as an independent contractor for another law firm. The other law firm has a health insurance policy which also covers my client' shareholder. The shareholder reimburses the full costs of his health insurance premiums to the other law firm which is paid through the S-Corp. Based on this situation I take it that the S-Corp would probably not be entitled to a deduction and the shareholder would have to deduct the premiums paid on Sch A subject to 7.5% of AGI. Can someone confirm my thinking?

[Jiggers]

S-Corporation Health Insurance

Health insurance paid by an S-Corp is deductible as wages, and must be added to the W-2 of the 2% & greater shareholder. The shareholder then gets to deduct on page 1 of the 1040 as self-employed health insurance. While it is considered wages, it is not subject to SS & Medicare taxes.

Now the problem is, due to recent IRS notices, does this plan qualify as one set up by the S-Corporation and is it in the name of the S-Corporation? Probably not. Then I would probably have to show this as a non-deductible expense on the 1120S, and probably take it as a medical expense, subject to the 7½ haircut on Schedule A.

[Taxman]

Hey

Jiggers, thanks for the response. That's my way of thinking too and I'm afraid if I report it like you mentioned in the first part of your post and the IRS were to take a close look at it they would say it's not set up by the S-Corp and it should be taken on Sch A instead.

[veritas]

Explain 162(I) to me

) Special rules for health insurance costs of self-employed
individuals
(1) Allowance of deduction
(A) In general
In the case of an individual who is an employee within the meaning of section 401(c)(1), there shall be allowed as a deduction under this section an amount equal to the applicable percentage of the amount paid during the taxable year for insurance which constitutes medical care for the taxpayer, his spouse, and dependents.
(B) Applicable percentage
For purposes of subparagraph (A), the applicable percentage shall be determined under the following table:
For taxable years beginning 2The applicable
in calendar year - percentage is -
1999 through 2001 60
2002 70
2003 and thereafter 100.
(2) Limitations
(A) Dollar amount
No deduction shall be allowed under paragraph (1) to the extent that the amount of such deduction exceeds the taxpayer's earned income (within the meaning of section 401(c)) derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established.
(B) Other coverage
Paragraph (1) shall not apply to any taxpayer for any calendar month for which the taxpayer is eligible to participate in any subsidized health plan maintained by any employer of the taxpayer or of the spouse of the taxpayer. The preceding sentence shall be applied separately with respect to -
(i) plans which include coverage for qualified long-term care services (as defined in section 7702B(c)) or are qualified long-term care insurance contracts (as defined in section 7702B(b)), and
(ii) plans which do not include such coverage and are not such contracts.
(C) Long-term care premiums
In the case of a qualified long-term care insurance contract (as defined in section 7702B(b)), only eligible long-term care premiums (as defined in section 213(d)(10)) shall be taken into account under paragraph (1).
(3) Coordination with medical deduction
Any amount paid by a taxpayer for insurance to which paragraph
(1) applies shall not be taken into account in computing the amount allowable to the taxpayer as a deduction under section 213(a).
(4) Deduction not allowed for self-employment tax purposes
The deduction allowable by reason of this subsection shall not be taken into account in determining an individual's net earnings from self-employment (within the meaning of section 1402(a)) for purposes of chapter 2.
(5) Treatment of certain S corporation shareholders
This subsection shall apply in the case of any individual treated as a partner under section 1372(a), except that -
(A) for purposes of this subsection, such individual's wages (as defined in section 3121) from the S corporation shall be treated as such individual's earned income (within the meaning of section 401(c)(1)), and
(B) there shall be such adjustments in the application of this subsection as the Secretary may by regulations prescribe.


Where does it say that a plan must be in the Corporate name? Or that the corporation needs to pay the premiums?

And did the advice of chief counsel advice((CCA) 200524001) stating such come under the heading "Secretary"?

[cpadan]

) Special rules for health insurance costs of self-employed
individuals
Where does it say that a plan must be in the Corporate name? Or that the corporation needs to pay the premiums?

And did the advice of chief counsel advice((CCA) 200524001) stating such come under the heading "Secretary"?

That question just came up on the ATX board, my response is repeated here (per RIA):
(Neil Harl also discussed this in the latest issue of Agricultural Law Digest)

No above-the-line deduction for health insurance bought by sole S corporation shareholder-employee
IRS e-News, Headliner Volume 163, May 15, 20006
In an article on its web site, IRS has explained how an S corporation's sole shareholder-employee, unlike a sole proprietor, can't buy health insurance in his own name and get an above-the-line deduction for the premium expense.

The problem. In an Internet article, “Health insurance covering S corporation shareholders,” IRS notes that some states do not allow a corporation to purchase a group health plan with only one participant, e.g., an S corporation's sole shareholder-employee. In this situation, the S corporation shareholder-employee may be forced to purchase the plan in his own name. While recent IRS guidance has allowed a favorable result where the owner of a sole proprietorship bought health insurance in his own name, this guidance is of no help to the S corporation sole shareholder-employee.

Background on treatment of sole proprietor. A self-employed individual can deduct as a business expense 100% of the amount paid during the tax year for medical insurance on himself, his spouse and his dependents. ( Code Sec. 162(l)(1) )

In Chief Counsel Advice (CCA), IRS concludes that a self-employed individual who is a sole proprietor and who purchases health insurance in his own name can treat the health insurance as purchased in the name of his business. As such, the insurance qualifies under Code Sec. 162(l) , and the self-employed individual can claim an above-the-line deduction for the insurance premiums. ( Chief Counsel Advice 200524001 )

Sole S corporation shareholder. In contrast to a sole proprietorship, if the business is operating as an S corporation, a different tax consequence applies for a sole shareholder-employee who purchases health insurance in his own name.

Health insurance bought by S corporation. For certain fringe benefits, including health insurance premiums, an S corporation is treated as a partnership, and any shareholder who owns more than 2% of the S corporation's stock (a “2% shareholder”) is treated as a partner. ( Code Sec. 1372(a) ) Accident and health insurance premiums paid by a partnership on behalf of a partner are guaranteed payments under Code Sec. 707(c) if the premiums are paid for services rendered in the capacity of a partner and to the extent the premiums are determined without regard to partnership income. ( Rev Rul 91-26, 1991-1 CB 184 ) As guaranteed payments, the premiums are deductible by the partnership under Code Sec. 162 (subject to the capitalization rules of Code Sec. 263 ) and includible in the partner's gross income.

Thus, while health insurance premiums paid by an S corporation aren't deductible by the S corporation as a fringe benefit, they are deductible by it as compensation to the 2% shareholder. The health insurance premiums paid by the S corporation for the 2% shareholder is included in his W-2. A 2% shareholder who is considered a partner under Code Sec. 1372 is treated as a self-employed person and, assuming all other requirements are met, can deduct the health insurance premiums paid by the S corporation as an above-the-line deduction. ( Code Sec. 162(l)(5) )

Health insurance bought by S shareholder. A problem arises if the sole shareholder-employee buys the health insurance in his own name instead of the S corporation's. Because the S corporation has not established a plan to provide medical care coverage, IRS reasons that there is no fringe benefit paid to the 2% shareholder. Code Sec. 1372 does not come into play. As a result, the S corporation is not treated as a partnership, and the shareholder is not treated as a partner. The shareholder is not considered self-employed and isn't eligible for the above-the-line deduction under Code Sec. 162(l) . This result isn't changed by the fact that state law doesn't allow the S corporation with one shareholder-employee to buy health insurance. However, the shareholder is still able to deduct the health insurance as an itemized deduction, subject to the 7.5% adjusted gross income limit for medical expenses.

RIA observation: A possible way for an S corporation sole shareholder to avoid this situation, is to employ his or her spouse or child as a bona fide employee of the S corporation, i.e., one that performs more than nominal or insignificant services. If state law then allows the S corporation itself to purchase the plan because the group health plan covers more than one participant, it can establish a plan to provide medical care coverage, and the sole shareholder can get an above-the-line deduction for the premium expense.
RIA observation: Another popular form of doing business by an individual is the limited liability company (LLC). Under the check-the-box rules, where there is no election to be treated as a corporation by a single member LLC, the LLC is disregarded for tax purposes, and the owner is the taxpayer. Thus, in determining the deductibility of health care insurance bought by a sole LLC shareholder, rather than by the LLC itself, presumably the same treatment as for a sole proprietor would apply, and the individual LLC shareholder could claim an above-the-line deduction for the health insurance he bought.
References: For the self-employed health insurance deduction, see FTC 2d/FIN ¶ L-3510 ; United States Tax Reporter ¶ 1624.403 ; TaxDesk ¶ 304,420 ; TG ¶ 16277 .


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[veritas]

I'm kind of simple but code section 162(I) says I as an employee of my S-Corp can deduct my health insurance premiums. It does not say a plan has to be in place of any sort. It does not talk about discrimination. I am meerly limited by my wages or coverage by another plan. I say the chief counsel who is not writing a regulation is off in outer space. I don't think any regulations have been written that address this? I would read the reference to 1372(a) to mean I am self employed the same as a partner.

Now that I think of it more this is the same reasoning that cost us the deduction in the first place. At one time we deducted our health insurance premiums as an employee benefit in a S Corp. Then the service got to looking at the code and found that we are to be treated the same as a partnership hence no deduction for health insurance. My beleif is 162(I) was put into place to give us equity( along with sole proprietors and partners) with the C Corp. The Sub Chapter S code section came into play during Eisenhower's term (I believe) and was predicated on partnership rules. Probably to give limited liability for partners when no other remedy was available.

Correct me if my memory is incorrect.

[geekgirldany]

I agree with veritas. To me it is a headliner not a ruling. I believe I've posted about this before. I am sticking with it being a adjustment.

[outwest]

My take is..

a CCM will be the position the IRS takes to challenge this. The court may rule this litigation position wrong or right.

None the less, if this limited set of facts comes up, I will explain to the client that the IRS has taken an untested position against the treatment. You may win or you may lose, I don't know. If you want to take it and you are audited, you may face the choice of 1) giving in and paying additional tax or 2) spending the money to litigate in court.

Now client, what is your choice?

and my file will document this discussion.

[Taxman]

outwest

thanks for the post. I think that's what I'm going to do with this client since the way he has obtained health insurance for himself as a single S-Corp shareholder is a little off and if audited, the IRS would challenge.

[Gretel]

Today I got a mailing from a company in regards to this issue.

They suggest to set up HRA Health Reimbursment Arrangement): Since the S Corp. has established a health benefit plan for its employee, that greater than 2% shareholder must be treated as a partner under Sec.1372.

Then the premiums paid can be included in wages.

I think I would set up HRA, but don't know how formal it has to be.