One Person S Corporation Health Insurance Deduction at Risk, Advises

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Sole owner/shareholders of an S corporation may be surprised to learn that only a true group health insurance plan will be an above-the-line tax deduction on their 1040 return for 2006. IRS Headliner 163 released on May 15, 2006 says health insurance must be in the name of the S corporation to be an above-the-line deduction. Find the solution at

Core Documents, Inc. the nation's primary source for affordable Section 125 and Section 105 HRA plans claims they have a solution to the problem IRS Headliner 163 has created for one person S corporation owners. See Core Documents at

First, let's outline how S corporation owners took health insurance deductions before IRS Headliner 163. For fringe benefit purposes, the S corporation is treated as a partnership and owners are treated as partners under IRS Section 1372. And under IRS Section 162(l)(5), because the S corporation owner is treated as a partner, he is treated as self-employed and is able to deduct health insurance premiums as above-the-line deductions on the 1040 Form, for income tax deductions only. The 15.3% self-employment tax still applies.

After IRS Headliner 163 the sole shareholder/employee or owner of an S corporation who purchases health insurance in his or her name instead of the name of the S corporation will no longer be able to take an above-the-line tax deduction. To take the above-the-line deduction health insurance must be purchased in the name of S corporation (a group plan). The deduction for policies purchased in the name of the sole shareholder/ employee will now be an itemized deduction subject to the 7.5% AGI limitation. Which means most owners will lose all or most of the health insurance deduction.

In an effort to make this as simple as possible as it relates to deductibility: Group Health Insurance - Good; and Individual Health Insurance - Bad. However, Core Documents has a solution. Before I show you the solution let's clarify exactly how IRS Headliner 163 will affect the S Corporation Owner's tax return in more detail.

Two different health insurance tax consequences are created by IRS Headliner 163:

Group Insurance: The owner purchases group health insurance in the name of the S corporation; the company pays the owner's premium; the premium payments are deducted by the company as W-2 income to the owner; income is reported in Box 1 of the W-2 for income tax; and Boxes 3 or 5 of W-2 as wages for Social Security, Medicare and FUTA tax. Because the health insurance is a Group Plan (key point) it can be taken as an "above-the-line" 1040 deduction from gross income. Above-the-line simply means the deduction can be taken off the top of gross income regardless of whether the owner itemizes deductions. This method saves only income tax. The owner still pays the 15.3% self-employment tax (aka Social Security & Medicare) and FUTA tax on insurance premiums.

Individual Health Insurance: The owner purchases health insurance in his or her name; the S corporation pays the premium; the premiums are deducted by the company as W-2 income to the owner; income is reported in Box 1 for income tax, Boxes 3 or 5 of W-2 for Social Security, Medicare & FUTA taxes. Because the health insurance is in the name of the owner, (key point) the owner would have to itemize the deduction which would be subject to the 7.5% AGI limitation. The 7.5% AGI limitation only allows the Owner to deduct expenses that exceed 7.5% of his or her Adjusted Gross Income (AGI). (Example: owner has $100,000 AGI; 7.5% = $7,500; health insurance deductions will only be allowed in excess of $7,500). The owner pays income tax on most of the premium, and 15.3% self-employment tax on the entire premium. Almost no deductibility at all.

Core Documents' Solution: The S corporation owner who is also an employee should establish a Section 105 Health Reimbursement Arrangement or HRA at for a one-time setup fee of $99. The Section 105 HRA is technically an ERISA health and welfare plan, (self-funded health plan with limited liability). The HRA is sponsored by and in the name of the S Corporation which meets the requirement of IRS Headliner 163 for a "group" plan. Under IRS 213(d) the Section 105 HRA plan allows deductions for individual health insurance, plus an added bonus of out-of-pocket medical, dental and vision expenses (bonus #1). IRS Headliner 41 says if payments to the Owner/employee are made under a "Plan" (such as the Section 105 HRA Plan) the amount would only be subject to income tax withholding, or Box 1 of Form W-2, and would not be included in Boxes 3 or 5 of Form W-2 for Social Security or Medicare, nor would it be subject to FUTA. Because the reimbursements are made from a Section 105 HRA "Plan" in the name of the S Corporation, the individual insurance premium is an above-the-line deduction, taken off of gross income even if the Owner doesn't itemize. The Section 105 HRA method saves the Owner all the income tax (bonus #2), plus all the 15.3% self-employment tax (bonus #3), plus the FUTA tax (bonus #4). No taxes at all, plus you have the added benefit of tax-free out-of-pocket medical expenses.

For more information contact Gene Ennis, Certified in Flexible Compensation, and President of Core Documents, Inc. ( by calling 1-888-755-3373.

Disclosure: Core Documents, Inc. does not provide tax or legal advice. Because the ideas expressed in this press release depend on compliance with income tax guidelines set forth in: IRS Headliner 163 and 41; and different portions of IRS Sections 1372, 162, 105, 106 and 707; and Revenue Ruling 91-26, you are advised to consult with your tax advisor for such guidance before implementing any ideas expressed herein.


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