Q: Tax Playa, can I get a tax deduction for paying for health insurance if I am self-employed?
Leon, Providence RI
A: The tax treatment of health insurance premiums varies widely, from pre-FICA and pre-income tax to no deduction at all. In the middle are the self-employed, who get the deduction only pre-income tax...
There are several ways that health insurance premiums are tax-advantaged:
- C-corporations can pay for health insurance for owners and employees
- C-corporations can offer a pre-tax payroll deduction (cafeteria plan) for health insurance premiums for owners and employees. This both pre-FICA and pre-income tax.
- S-corporations can pay for health insurance or offer a payroll deduction plan for employees that own less than 2% of the company. Once again, these are pre-FICA and pre-income tax.
- Partnerships and sole proprietorships can do the same for non-owners.
- The uninsured can take a deduction for health insurance premiums if they qualify for the catastrophic medical expenses itemized deduction.
That leaves several classifications of taxpayers: general partners, the self-employed, and more than 2% owner-employees of S-corporations.
For these people, an above-the-line adjustment to income is available for health insurance premiums paid. The adjustment cannot be more than net business income from the activity, and is not available for any month in which the adjuster had access to an employer-sponsored health insurance plan. This is only a pre-income tax deduction, so self-employment tax is unaffected.
For general partners and the self-employed, taking the adjustment is easy. One simply enters it on the 1040 and reduces gross income by this amount.
It's more complicated for more than 2% shareholder-employees of an S-corporation. In this case, the company must add the amount of health insurance it pays on behalf of these employees to their W-2 wages. While it is added to box 1 (income), it is not added to box 3 (Social Security wages) or box 5 (Medicare wages). Then, the S-corporation owner includes the inflated wages on his 1040, but takes the adjustment for self-employed health insurance premiums paid.
Needlessly complex, but this is after all taxes.