1. What is an S Corporation?
2. Health Insurance Employee Benefit for a S Corporation
3. How Does the IRS Determine 2% Shareholders?
4. The Affordable Care Act’s Effect on S Corporations

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.

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).

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.

If you need help with s corp owner health insurance or any other legal need, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5-percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with, or on behalf of companies like Google, Menlo Ventures, and Airbnb.