How S Corp Shareholder Health Insurance Works

flower shop owner looking at a laptop open to health insurance options

Forming a company as an S corp has some outstanding tax advantages for business owners. No corporate income taxes are paid, and considerable amounts of money may be saved on payroll taxes. Distributions to shareholders are taxed at their personal level and tax rate and are not subject to self-employment taxes.

While there are tremendous benefits to being taxed as an S corp shareholder, one drawback comes with health insurance benefits for owners. Anyone with over 2% ownership who works in the business cannot count health insurance as a fringe benefit.[1]

Can Your S Corp Pay for Group Medical Insurance

An S corp can pay for and offer group health insurance to its employees just like any other business. While the employees may count their health insurance as a non-taxable fringe benefit, owners cannot. The owner’s health insurance is considered to be part of their compensation package and will be taxed.

Their W-2 will reflect this as income.

Can S-Corp Owners Deduct Medical Insurance Premiums

Because S corp owners report their health insurance premiums the same as other self-employed individuals, they can deduct the premiums for themselves, spouses, and dependants.

The deduction is not a business deduction; it is a personal deduction and is taken on the first page of your IRS Form 1040.[2] Regardless of whether the owner purchases the insurance as an individual or it is purchased and paid by the company, the S corporation business owner may take the deduction; however, the company must ultimately pay the premiums, whether outright or as a reimbursement to the owner.[3]

What Is a 2% Shareholder?

A 2% shareholder works within the business and owns more than 2% of the company. If an employee is given 3% ownership as a gift, that employee is now taxed on what was previously an untaxed fringe benefit.

S-Corp Health Insurance Affordable Care Act (ACA) Compliance

The Affordable Care Act (ACA) made a number of changes to how small businesses treat and account for health insurance. While only businesses with over 50 employees are required to provide health insurance benefits for employees, this doesn’t mean the S corp owner can have the company pay for their health insurance and not provide any insurance for the employees.

The ACA prohibits discrimination regarding health care benefits, meaning a company cannot offer coverage to some employees and not to others. However, the specifics regarding eligibility can be complex and depend on various factors such as the size of the business and the type of insurance plan. For example, business owners with 50 or more full-time employees are required to provide minimum essential coverage to at least 95% of those employees.[4]

Furthermore, employers may provide different tiers of coverage to employees, but they must comply with certain minimum requirements and standards set by the Affordable Care Act.

Additionally, the ACA requires that the policy purchased must be a group policy, or alternatively, employers must offer reimbursement for individual health insurance premiums through options such as HRAs (Health Reimbursement Arrangements) – although this is subject to specific conditions.[5] However, if an employer instructs an employee to purchase health insurance from the health insurance exchange and then offers reimbursement, it could be considered a violation of the law.

HSA Requirements for S-Corp Shareholders

Health savings accounts (HSAs) are an excellent way for employees to save tax-free dollars for future medical expenses, but owners do not share in these tax-free benefits. If the company contributes to an HSA on behalf of a more than 2% shareholder-employee, the contribution is considered a taxable benefit.[6]

flower shop employee and owner working on an order together

Like owner health insurance, the shareholder can deduct the contribution above the line of their individual tax return.

Additionally, the S corporation owner may not make pre-tax contributions to their own HSAs through the company using salary reductions.

How do HRAs affect S-Corp Owners?

Many S corp owners wonder how the rules applied to S corps impact their eligibility to participate in a health reimbursement arrangement (HSA) and enjoy those tax-free benefits.

Just like HSAs, the S corp owner does not get to participate in these tax-exempt health care plans. HRAs are only available for regular W-2 employees, and S corp owners are once again taxed as receiving compensation. An S corporation owner and their family do not qualify as company employees.

Even utilizing an HRA for tracking purposes, the S corp employee-owner with over 2% ownership will never be able to take advantage of pre-tax benefits.

Still, It’s Fabulous To Own an S Corp

flower shop owner and her employee completing an order for pick up

Employee misclassification is the fourth most common trigger for a small business audit. If you have few employees but lots of independent contractors, the IRS may want to dig deeper to see whether you’re incorrectly classifying these workers to avoid payroll taxes, workers’ compensation and liability insurance, and overall labor costs.

Owners with over 2% ownership who work within the company must include health insurance as part of their income, subject to state and federal taxes. Unfortunately, participation in tax-saving plans such as HSAs and HRAs is restricted for these owners. Despite these considerations, owning an S corp brings forth numerous advantages beyond health benefits:

Reduced Payroll Taxes

S corp owners paying themselves a “reasonable salary” only incur payroll taxes on the salary itself. State and federal income taxes are applicable to distributions at their personal tax rate. This structure allows for potential tax savings, particularly on the portion of income beyond the reasonable compensation.

Non-Employee Owners Save On Payroll Taxes

In contrast to LLCs or partnerships, non-active owners in an S corporation don’t pay payroll taxes on their distributions. This absence of double taxation proves advantageous for shareholders numbering fewer than 100.

Benefits are Tax Deductible

Tax-deductible benefits, including insurance and pre-tax benefits, reduce the owner’s income on tax forms. If these benefits surpass the standard deduction, S corp owners experience financial savings.

In essence, while navigating health insurance deductions may seem intricate for S corp owners, the overall benefits outweigh the drawbacks, especially when considering the broader spectrum of advantages the structure provides.

 

Work With Experts

RCReports collaborates with professionals dealing with S corporation owners, aiding in the determination of reasonable compensation. This process not only saves them from unnecessary taxes but also maximizes the benefits derived from their businesses. To unravel the advantages of an S corp and effectively navigate owner healthcare benefits, a demo of RCReports is the perfect start.

References

1. S Corporation Compensation and Medical Insurance Issues. (2023, June 26).  Internal Revenue Service. https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues#limitations

“A 2-percent S corporation shareholder-employee is not eligible to participate in a QSEHRA. For more information see Question 9 in Notice 2017-67 and IRC § 1372.”

2. Rivelli, E. (2023, March 10). When Can I Deduct Health Insurance Premiums On My Taxes? Forbes. https://www.forbes.com/advisor/health-insurance/is-health-insurance-tax-deductible/

“‘Self-employed health insurance premiums are deductible as an ‘above the line’ deduction on Form 1040, which means you can deduct the premium even if you don’t itemize deductions on Schedule A,’ says Hunsaker.”

3. S Corporation Compensation and Medical Insurance Issues. (2023, June 26). Internal Revenue Service. https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues#limitations

With respect to coverage of employees who are not 2-percent shareholders, Notice 2015-17 explains that if an S corporation maintains more than one reimbursement arrangement covering both 2-percent shareholder-employees and non-2-percent shareholder-employees, the arrangements would be considered a group health plan and would not be exempted under the “fewer than two participants who are current employees” exception to the market reforms. Such a plan would generally fail to satisfy the ACA market reform requirements and thus may trigger the excise tax under IRC § 4980D with respect to the non-2-percent shareholder employees.”

4. Employer Shared Responsibility Provisions. (2023, October 23). Internal Revenue Service. https://www.irs.gov/affordable-care-act/employers/employer-shared-responsibility-provisions

“An ALE member will owe the first type of employer shared responsibility payment if it does not offer minimum essential coverage to at least 95 percent of its full-time employees (and their dependents), and at least one full-time employee receives the premium tax credit for purchasing coverage through the Health Insurance Marketplace.”

5. Health Insurance For Businesses. (n.d.). HealthCare.gov. 

https://www.healthcare.gov/small-businesses/learn-more/explore-coverage/

 S Corporation Compensation and Medical Insurance Issues. (2023, June 26). 

6. Internal Revenue Service. https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues#limitations

The bottom line is that in order for a shareholder to claim an above-the-line deduction, the health insurance premiums must ultimately be paid by the S corporation and must be reported as taxable compensation in the shareholder’s W-2.”

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