Many business owners have heard that they can use their health insurance premiums to reduce taxes, which is absolutely true! The confusion sets in around how exactly these premiums reduce taxes. This fast tax tip shows you how.
Yes, your business can pay for your health insurance premiums. Unfortunately it makes little difference, for tax purposes, to have your business pay for your premiums. This excludes S Corp owners (with more than 2% stock) who do get tax savings by allowing their business to pay for or reimburse their health insurance premiums.
To put it differently: while self employed people can use their health insurance premiums to reduce taxes, paying for them through their business isn’t usually necessary. Moreover it can create additional bookkeeping and paperwork for your business, you’ll want to avoid.
There's a big exception here for S Corp owners, which we'll discuss in detail below. However first let's talk about these tax savings.
Questions business owners have about health insurance usually come down to claiming the “Self Employed Health Insurance Deduction”. There’s a misconception that your business needs to pay for your insurance premiums in order to allow you to deduct them. Thankfully that’s not necessary for most businesses. This article will help you learn everything you need to know to maximize this deduction with minimal effort!
Self Employed Health Insurance Deduction
Let’s start with the good news: health insurance premiums are 100% deductible to business owners on their personal (not business) taxes. Employees can itemize their health insurance premiums, but it’s not nearly as beneficial as the self employed health insurance deduction. Business owners can take this deduction, in addition to the standard deduction, to reduce their income taxes.
Who Can Get This Deduction
First off you need to be an owner of a sole prop, partnership, regular LLC, or S Corp. Obviously you also need to be paying medical insurance premiums, however dental or long-term care insurance counts also. Finally your business must be profitable because you can only deduct as much as your business earns (we’ll go over examples soon).
You may not deduct when:
Your business has not earned any income.
You are able to join a spouse’s health care plan.
You are able to get health care coverage from a W-2 job.
Can include premiums paid for your spouse and dependents!
Can include medical, dental, or long-term care premiums.
The policy can also cover any child who is under the age of 27.
It’s a special deduction that can be taken along with a standard deduction.
Important limitations to be aware of:
You can only deduct as much as your self employment income.
You must choose a single business’s income for the deduction amount.
A “below the line” deduction which has no impact on your self employment taxes.
Example Tax Savings
Jake a sole proprietor that earned $9,000 in taxable income from self employment. He paid $2,000 in health care premiums, which means he can claim a $2,000 deduction. Jake saves $200.
Janet is a partner in an LLC that gave her $6,000 in self employment income. Her taxable income is $40,000 and she paid a total of $8,000 in premiums for herself as well as her husband and child. She can claim a $6,000 deduction saving her $720.
Janet’s Missing $2,000
Janet would have gotten a full 100% deduction of $8,000, however her self employment income was only $6,000. That’s why she missed out on that additional $2,000 deduction.
These are serious savings that you wouldn’t be getting as an employee! Employees have a less value itemized deduction available to them. However due to the increased standard deduction from the Tax Cuts and Jobs Act, this deduction will likely go unclaimed. This is another reason why the self employed save on taxes!
What Health Insurance Qualifies?
As long as the plan is for medical, dental, or qualified long-term care insurance it’s generally applicable for your deduction. As you can see, the IRS will equally accept a policy in your name or that of your business:
- Sole Proprietors and Single Member LLCs: the policy can be either in the name of the business or in the name of the individual.
- For partners and Multi-Member LLCs: a policy can be either in the name of the partnership or in the name of the partner. Either you or the partnership can pay them.
Whether the policy is for you or your business: check with your CPA to make sure you are not creating extra bookkeeping and paperwork. As mentioned at the beginning there’s no tax advantage either way for most businesses!
Health Insurance: S Corp’s Super Power
A very misunderstood, but tremendously important, tax advantage of the S Corp is how health insurance premiums create even more savings! This applies to every owner of more than 2% of the company’s shares. In addition to the personal deduction we’ve talked about above, S Corp owners are able to use their premiums to reduce their self employment taxes, even more than they already do.
A subchapter S is a tax classification, used by corporations, to pass income and losses through to its members in the form of employee salaries or distributions.
The benefits of S Corps paying their owner's health insurance premiums are 2 fold:
Premiums paid help reduce your social security and medicare (self employment) taxes.
Premiums count towards your "reasonable compensation", which will help to draw less scrutiny from the IRS.
You’ll have to pay income tax on this added compensation you received in the form of premiums. How this works gets complicated, just know that it’s another net tax savings for S Corp owners.
You don’t need to have your business pay your health insurance premiums unless you have a good reason (like you’re an S Corp owner). Business owners should instead focus on claiming the maximum self employed health insurance deduction. As we’ve seen this deduction can result in huge savings, but be sure you really can avoid the common roadblocks:
Check that you don't qualify for a spouse's plan.
Check that you don't qualify for a plan from your regular job.
It’s critically important your accountant is aware of all the health insurance premiums you are paying. This is especially true if you’re an S Corp owner, so ensure you’re documenting all premiums paid correctly. S Corp owners can use this information to claim even greater tax savings in addition to the income tax deduction.
Want to learn more about how an S Corp could create massive savings for your LLC? Please try our free, zero sign up, S Corp tax savings calculator for your state.