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Health Insurance and S Corporations

If you are a shareholder in an S-corporation, or if you are responsible for the accounting or tax needs of an S-corporation, you should be aware of the following information contained in IRS Notice 2008-1.

S Corporations that pay accident or health insurance premiums on behalf of a 2-percent employee-shareholder must include those payments as wages for income tax withholding purposes on the Shareholder’s Form W-2.


What if the shareholder’s ownership percentage is less than 2%?

IRS Notice 2008-1 indicates that only 2-percent shareholder-employees include these premiums on Form W-2. The term “2-percent shareholder” is any person who owns on any day during the taxable year of the S corporation more than 2 percent of the stock of the corporation.


What if the shareholder does not receive a Form W-2?

Accident and health insurance premiums paid or furnished by an S corporation on behalf of its 2-percent shareholders are considered fringe benefits generally furnished in consideration for services rendered. However, a 2-percent shareholder is not an employee for purposes of Sec 106. Accordingly, the premiums are not excludable from the 2-percent shareholders gross income under Sec 106. Therefore, these payments should be included on the 2-percent shareholder employees Form W-2. An S-corporation is entitled to deduct the cost of such employee fringe benefits on its income tax return.

Are the accident or health insurance premiums included on the 2-percent shareholders W-2 subject to Social Security and Medicare taxes?

The wages are not subject to Social Security and Medicare taxes.

Can the shareholder deduct the accident or health insurance premiums included on his or her Form W-2 on his or her Individual Income Tax Return Form 1040?

The 2-percent shareholder-employee may claim the premiums that constitute medical care for the taxpayer, his or her spouse, and dependents as a deduction from the taxpayers adjusted gross income.

How is the deduction taken?

The deduction is usually taken on page one of the shareholders Form 1040.

Are there any restrictions to the deduction by the shareholder on his or her Form 1040?

The deduction is not allowed to the extent that the amount of the deduction exceeds the earned income derived by the taxpayer from the trade or business with respect to which the plan providing the medical coverage is established. Also, the deduction is not allowed for amounts during a month in which the taxpayer is eligible to participate in any subsidized health plan maintained by an employer of the taxpayer or the spouse of the taxpayer.

Can the S corporation reimburse the shareholder for accident or health insurance premiums paid by the shareholder?

Yes. If the 2-percent shareholder makes the premium payments and furnishes proof of premium payments to the S corporation and then the S corporation reimburses the 2-percent shareholder-employee for the premium payments in the current tax year.

If the S corporation does not include the accident or health insurance premiums on the 2-percent shareholder’s Form W-2 can the S corporation still deduct the premium payments?

An S corporation is entitled to deduct the cost of employee fringe benefits under Section 162(a). However, the requirement to include the premium amounts paid on behalf of 2-percent shareholder employees is not optional. Therefore, amounts paid and deducted by the S corporation must be included on the 2-percent shareholders W-2. The Notice 2008-1 indicates that timely filed amended returns to claim the deduction under Section 162(l) may be filed if the taxpayer satisfies the requirements of the Notice.


Remember to always consult with your tax advisor regarding your income tax needs.

IRS Strengthens Withholding Compliance Program
The IRS has stepped up its withholding compliance program by making more effective use of information reported on W-2 wage statements to ensure that employees have enough federal income tax withheld from their paychecks. At the same time, employers are no longer required to submit potentially questionable Forms W-4 to the IRS.
For more information:
Withholding Compliance Questions & Answers
IRS Strengthens Withholding Compliance Program; Reduces Paperwork for Employers

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