Key Takeaways

  • S corporation owners who hold 2% or more of company stock are treated differently from regular employees for health insurance tax purposes.
  • The Affordable Care Act (ACA or “Obamacare”) imposes rules that can lead to penalties for noncompliant health reimbursement arrangements (HRAs) or reimbursements made outside qualified group plans.
  • Premiums paid for 2% shareholders must be included in their wages but can still qualify for a personal tax deduction if structured correctly.
  • Family members of 2% shareholders may qualify for the same deduction under certain IRS guidance.
  • S corporations must report shareholder health premiums properly on Form W-2 and comply with ACA market reforms to avoid $100-per-day per-employee penalties.
  • Professional tax or legal advice is recommended when structuring S corporation health plans to ensure both compliance and tax efficiency.

S corp owner health insurance is an issue that owners with this type of business entity need to think about. While many employees are accustomed to getting their insurance through their employers, if an employee is also a shareholder in the business, then it gets more complex (and potentially expensive).

What is an S Corporation?

Many owners of companies elect to file the paperwork with the Internal Revenue Service to become an S corporation (or S corp). This filing represents the company’s formal request that the IRS treat them in a certain way for tax purposes. There are many tax advantages to this election. One of the most exciting advantages is the opportunity to mitigate or lower the Medicare and Social Security taxes.

Health Insurance Employee Benefit for a S Corporation

One drawback to the S corporation is that employee/owners cannot deduct the cost of health insurance from taxes. While an S corp has pass through taxation, like many other forms of tax elections, in respect to health insurance premiums, the law gets more complex. S corps have complicated issues with health insurance premiums paid for their shareholders. The Affordable Care Act has given rise to even more issues.

S corporations are able to provide health insurance benefits to their employees as a perk. The S corporation can then deduct the cost of their premiums from their taxes as a business expense.

However, if the employee is also a shareholder of 2% or more of the company stock, then the cost of the health insurance benefits (and assorted other benefits) must be included in that employee’s taxes as income.

This means that shareholder/employee must pay income tax on the premiums and also Medicare and Social Security tax on that amount. Also of note, if a shareholder had hoped to get around the rule by employing a spouse and providing that spouse with health insurance through the company, they are out of luck. A spouse and family members are also shareholders for the purposes of this rule. This is true whether they have stock in their names or not.

IRS Rules for Deducting S Corporation Health Insurance Premiums

Under IRS Notice 2008-1 and later guidance, a 2% shareholder in an S corporation may claim a self-employed health insurance deduction if the S corporation either:

  1. Pays the premiums directly for the shareholder’s coverage, or
  2. Reimburses the shareholder for personally paid premiums, provided the payment is included in the shareholder’s Form W-2 wages.

The shareholder then deducts these premiums “above the line” on their personal tax return (Form 1040, Schedule 1), reducing adjusted gross income. However, this deduction cannot exceed the shareholder’s earned income from the S corporation. If the shareholder or their spouse is eligible for another employer-sponsored plan, they cannot claim the deduction.

S corporations should report these premiums in Box 1 of Form W-2 (subject to income tax) but exclude them from Social Security and Medicare wages (Boxes 3 and 5). Proper payroll treatment ensures the shareholder can take the self-employed health insurance deduction and the corporation can deduct the expense as a business cost.

How Does the IRS Determine 2% Shareholders?

The Internal Revenue Service has defined a 2% shareholder as a person who owns (on any day during the tax year) more than 2 percent of outstanding stock of an S corporation. Self-employed owners are able to deduct health insurance premiums for themselves and their dependents. There is a deduction that is labeled an “offset” for this group of shareholders. The health care premiums paid are reportable in the itemized deductions as expenses for medical and dental.

In order to get this deduction, the shareholder must have the S corporation pay the premiums (even if they just reimburse the shareholder after the fact). For clarity, consider the following elements:

  • Who pays the premiums?
  • How are the premiums reported to the IRS?

There are exceptions to the 2% shareholder offset rule:

  1. The deduction must be less than the shareholders income from that S corporation.
  2. The shareholder cannot take the deduction if they are able to participate in another health plan from an employer (or even a spouse’s employer).

Health Coverage for Family Members of 2% Shareholders

The IRS has clarified that family members of a 2% shareholder — including a spouse, children, and certain relatives — are considered indirect shareholders for health insurance purposes. Under Chief Counsel Memorandum 201912001, the cost of health insurance coverage for a relative of a 2% shareholder can also qualify for the same tax treatment as the shareholder’s own coverage if the policy is established by the S corporation and the premium amounts are properly reported as wages.

This means that if an S corporation pays or reimburses the health insurance premium for a shareholder’s family member, the amount is treated as additional compensation to the shareholder, not the family member. The shareholder can then deduct the premiums as self-employed health insurance, as long as all other requirements (such as inclusion on Form W-2 and limits based on S-corp income) are satisfied.

The Affordable Care Act’s Effect on S Corporations

The Affordable Care Act or ACA, brought enormous changes to employer-provided healthcare plans. Plans for S corporations were already complex, but the ACA added a new wrinkle. It established new parameters that employee-provided group insurance plans must meet.

The ACA provisions must be met by the employer or face penalties or excise taxes. These provisions include the type of coverage provided and the cost of health insurance premiums. The excise taxes assessed when failing to meet the ACA standards can be very steep. If an S corp only has one employee or if a second employee is a spouse or dependent, these requirements do not apply.

Many S corporations have shifted to a direct pay model for health insurance. Instead of providing health insurance to their employees, they increase the compensation of their employees to allow them to acquire health insurance. Seeking professional help from an experienced tax professional or lawyer is always recommended.

Strategies to Manage S Corporation Health Coverage Costs

To reduce tax liability while staying compliant with ACA and IRS rules, S corporation owners can consider:

  • QSEHRA or ICHRA Plans: These allow small businesses to reimburse employees (including shareholder-employees) for individual coverage within ACA limits.
  • Increasing Wages to Offset Premiums: Some S corporations raise shareholder compensation instead of reimbursing directly for health insurance. The shareholder then purchases coverage independently and may deduct the premiums as self-employed health insurance.
  • Leveraging the Premium Tax Credit: Shareholders who purchase health coverage through the Health Insurance Marketplace (Obamacare exchange) might qualify for premium tax credits, but these credits are reduced or eliminated if the corporation reimburses their premiums directly.

By understanding both the ACA requirements and S corporation tax rules, owners can structure coverage to protect both compliance and deductibility while avoiding costly penalties.

ACA Compliance and Penalties for S Corporations

Under the Affordable Care Act (ACA), S corporations must ensure their health insurance plans comply with federal “market reform” provisions. The IRS and Department of Labor have clarified that employer reimbursement plans that pay or reimburse employees for individual health policies are considered group health plans and must comply with ACA rules on:

  • Annual dollar limits on essential health benefits, and
  • The requirement to provide certain preventive services without cost-sharing.

If an S corporation reimburses individual policy premiums outside a compliant group plan, it could face excise tax penalties of $100 per day per employee — totaling up to $36,500 annually per affected worker.

Safe Harbor for Small S Corporations:

  • The IRS has provided transitional relief (e.g., Notice 2015-17) for small S corporations with only one or two employees, particularly when both employees are owner-shareholders or family members.
  • These S corporations may continue to reimburse shareholder premiums without triggering ACA penalties, provided they report the premiums correctly on Form W-2 and meet self-employed deduction requirements.

Best Practice:To remain compliant, S corporations should avoid informal reimbursement arrangements and instead:

  • Adopt a qualified group health plan or a Qualified Small Employer Health Reimbursement Arrangement (QSEHRA) if eligible.
  • Ensure all premium payments are made through the S corporation and properly reported.

Frequently Asked Questions

  1. Can an S corporation pay for an owner’s health insurance under Obamacare?
    Yes, but it must follow specific IRS and ACA rules. Premiums must be paid or reimbursed by the S corp, included in the shareholder’s W-2 income, and reported properly to qualify for the self-employed health insurance deduction.
  2. Do family members of an S corporation owner get the same tax treatment for health insurance?
    Yes. Under IRS guidance, family members are treated as 2% shareholders for health insurance purposes, and their coverage can be included in the owner’s deduction if reported correctly.
  3. What ACA penalties can apply to an S corporation?
    Noncompliant reimbursement plans can trigger a $100-per-day-per-employee penalty for violating ACA market reform rules.
  4. Can an S corporation owner claim the Premium Tax Credit from the Obamacare exchange?
    Generally, no — not if the corporation pays or reimburses their health insurance. The credit applies only when the individual pays for the coverage directly and no employer reimbursement occurs.
  5. How can an S corporation remain compliant while providing health benefits?
    Use a compliant group plan, QSEHRA, or ICHRA; report premiums properly on Form W-2; and ensure that all reimbursements comply with ACA and IRS guidance.

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