A little known and less used section of the IRS Code allows a greater than 2% owner of an S Corp to receive a full deduction for the health insurance costs of their family that’s paid by the S Corp. In many instances, given the limitations of Schedule A, they currently lose all or part of that deduction.
An S Corp Owners Health Insurance is deductible, but not usually at the entity level. It’s normally deducted off of Schedule A, but is subject to a 7.5% of Adjusted Gross Income (AGI) Limitation.
This means that if the owner has an AGI of $300K, the first 7.5% or $22,500 that they spend on health insurance isn’t deductible. If they only spend $20,000 on health insurance in that year, they don’t get a deduction.
But this is no longer the case. In order to understand how this works, let’s set up a scenario.
Joanne B. Owner has an S Corp where she pulls a $50K W-2 and has additional K-1 income from the entity of $250K. The entity pays for a group health insurance plan that covers her and all of her employees.
Her portion of that health insurance plan is $20K annually. Normally she wouldn’t get a deduction for that $20,000 because it is under the limit for a Schedule A deduction. But in order for her to get a full deduction, we need to do the following.
1 – Add the Health Insurance To Her W-2. This would only increase Box #1 of the W-2 to $70K. Boxes 3 & 5 would remain the same, not increasing her Social Security and Medicare responsibilities. The $20K in health insurance is also added to box 14 on the W-2 for informational purposes
2 – We decrease her K-1 by the $20,000 that was added to her W-2.
So far in our example there’s no net change on her personal income tax return. We added $20K to her W-2 and deducted $20K from her K-1. The $300K net on her 1040 remains unchanged, but here’s where the magic happens.
3 – Given how the W-2 has now been completed, we’re allowed to take a Self-Employed Health Insurance Deduction on Line 17 of Schedule 1 for the entire amount. Normally she would lose the entire deduction, but now she gets the entire $20,000 write off.
At $300K she would be in the 35% income tax bracket at the federal level and 4.95% for the State of Illinois. Doing it this way just saved Joanne $7,900.
That’s not nothing.
Let me leave you with this.
You haven’t heard the best part. We can go back three years and get this money refunded if we complete amendments.
The hardest part of doing this is dealing with your payroll service. If you’ve ever tried to get someone on the phone at most of the larger services, you’ve got a better chance of winning the Lotto.
If you’d like to switch your payroll over to my service, where we answer the phone and actually speak English, please let me know. That would make getting you this deduction a lot easier.
Doing this for prior years would require us to amend your W-2, your S Corp Return, and your 1040, but it is possible. And in many instances, we’d be fools not to do this. I don’t know about anyone else, but I didn’t take my stupid pills today.
If you’d like us to explore this option for you and your business, please let me know.
We’re all going to get through this. Let’s get through it together.
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