Health Insurance Covering S Corporation Shareholders

Health Insurance Covering S Corporation Shareholders

Health Insurance Covering S Corporation Shareholders

NOTE: This headliner is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.


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Headliner Volume 163
May 15, 2006

In many solely owned businesses, the owner of the business will purchase health insurance in his or her own name versus the name of the business. The type of entity may greatly affect where this insurance premium expense may be deducted on the individual’s personal income tax return.

In Chief Counsel Advice (CCA) 200524001, it was held that a self-employed individual who is a sole proprietor and who purchases health insurance in his or her own name may treat that as health insurance purchased in the name of the sole proprietor business. As such, the insurance would qualify under the provisions of IRC §162(l). Assuming the self-employed individual meets the other provisions of IRC §162(l), the individual may claim a deduction for the insurance premiums in arriving at his or her adjusted gross income; also referred to as an above-the-line deduction.

In contrast, if the business is operating as an S corporation, there is a different tax consequence if the individual who is the sole shareholder and sole employee, purchases the health insurance in his or her own name.

For certain fringe benefits paid by the S corporation, including health insurance premiums, the Internal Revenue Code (IRC) holds that the S corporation will be treated as a partnership and any shareholder who owns more than 2% (a 2% shareholder) of the S corporation stock will be treated as a partner of such partnership (IRC §1372(a)). Revenue Ruling 91-26 holds that accident and health insurance premiums paid by a partnership on behalf of a partner are guaranteed payments under §707(c) of the Code if the premiums are paid for services rendered in the capacity of a partner and to the extent the premiums are determined without regard to partnership income. As guaranteed payments, the premiums are deductible by the partnership under §162 (subject to the capitalization rules of §263) and includible in the recipient-partner's gross income under §61.

As such, the health insurance premiums paid by the S corporation would not be deductible by the S corporation as a fringe benefit but would be deductible by the S corporation as compensation to the 2% shareholder. The health insurance premiums paid by the S corporation for the 2% shareholder should be included in the 2% shareholder’s W-2.

IRC §162(l)(5) holds that a 2% shareholder that is treated as a partner under IRC §1372 will be treated as a self-employed person and, assuming all of the other provisions of IRC §162(l) are met, may deduct the health insurance premiums paid by the S corporation as an above-the-line deduction. It should be remembered that there are some limitations under IRC §162(l)(2). The one that often affects a 2% shareholder deals with other coverage. An above-the-line deduction is not allowed for any calendar month for which the shareholder is eligible to participate in any subsidized health plan maintained by any other employer of the shareholder or of the spouse of the shareholder.

Assuming there are no other subsidized health plans, the problem arises if the sole shareholder/ employee purchases the health insurance in his or her own name instead of that of the S corporation. In that case, the S corporation has not established a plan to provide medical care coverage, there is no fringe benefit paid to the 2% shareholder and the provisions of IRC §1372 do not come into play. Since the provisions of §1372 do not come into play, the S corporation is not treated as a partnership and the shareholder is not treated as a partner. Since the shareholder is not treated as a partner, the shareholder is not treated as self-employed and is not eligible for the above-the-line deduction treatment under IRC §162(l). The shareholder is still able to deduct the health insurance as an itemized deduction which is subject to the 7.5% AGI limitation.

Some states do not allow a corporation to purchase a group health plan with only one participant. This prevents the S corporation from acquiring a health plan and it requires the shareholder to purchase the plan in his or her own name. That state law limitation does not override the requirements that the S corporation must provide fringe benefits to its employees in order to have the 2% shareholder qualify for the IRC §162(l) benefits.

In summary, contrary to the holding in CCA 200524001 dealing with a sole proprietorship, a shareholder/employee is not allowed to purchase health insurance in the shareholder’s own name and still obtain the above-the-line deduction benefits of IRC §162(l).


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Note: This page contains one or more references to the Internal Revenue Code (IRC), Treasury Regulations, court cases, or other official tax guidance. References to these legal authorities are included for the convenience of those who would like to read the technical reference material. To access the applicable IRC sections, Treasury Regulations, or other official tax guidance, visit the Tax Code, Regulations, and Official Guidance page. To access any Tax Court case opinions issued after September 24, 1995, visit the Opinions Search page of the United States Tax Court.