The IRS announced today a “clarification” of the rules for self-employed health insurance deductions for S Corporations. This is bad news overall, and especially bad news for California S Corporations.
The self-employed health insurance deduction allows sole proprietorships, partnerships, LLCs (those treated as partnerships or as disregarded entities) to deduct their health insurance premiums “above the line;” that is, an adjustment to AGI rather than as an itemized deduction subject to a 7.5% limitation on AGI. This is a large tax savings for the self-employed.
The IRS announcement indicates that for S Corporations to be eligible for this deduction, the policy must be in the name of the corporation. But if you do this, the health insurance premiums will be included as compensation on your W-2 (although they are exempt from FICA and medicare).
Additionally, many states, including California, do not allow single-employee corporations of any kind to obtain health insurance. This ruling means that California single-member S Corporations (a single individual is the employee and owner) are generally ineligible for this deduction.
For example, my health insurance premiums run about $5,000 annually. If I were impacted by this ruling and were in the 25% tax bracket, my federal tax bill just went up $1,250.
If you’re impacted by this ruling I urge you to write your Representatives and Senators. I’m certain this is not what Congress intended when they enacted this deduction.