Can You Take the Self-Employed Health Insurance Deduction?

If you're self-employed and pay for your own health insurance, you may have access to a valuable tax deduction. (How Do Owners of S Corporations Deduct Their Health Insurance?)

The self-employed health insurance deduction can reduce your adjusted gross income dollar for dollar. You don't have to itemize deductions to claim it, and lowering your adjusted gross income can sometimes help you qualify for other tax benefits that phase out as income increases.

But there's an important catch:

Paying for your own health insurance doesn't automatically mean the premiums are deductible as self-employed health insurance.

Three important tests can determine whether you qualify.

What Does the Self-Employed Health Insurance Deduction Cover?

The deduction isn't limited to traditional medical insurance.

Qualifying coverage can include:

• medical insurance;
• dental insurance;
• vision insurance; and
• qualified long-term care insurance, subject to applicable limitations.

Coverage can potentially include premiums paid for yourself, your spouse and your dependents.

There's also a useful provision for adult children. Qualifying health insurance premiums can include coverage for your child who was under age 27 at the end of the tax year, even if that child wasn't your dependent for the year.

Once you've identified the premiums, however, you still need to determine whether they pass the rules for the deduction.

Test #1: Was the Health Insurance Established Under Your Business?

The first question is whether the insurance was established—or is treated as established—under the trade or business generating the income that supports the deduction.

Exactly how you satisfy this requirement depends on how your business is structured.

Sole Proprietors

Sole proprietors have considerable flexibility.

The health insurance policy can generally be in the name of the business or in your own name.

That means a sole proprietor who purchases an individual health insurance policy personally, including qualifying coverage through the Health Insurance Marketplace, may still be able to claim the self-employed health insurance deduction.

You don't necessarily need a group health insurance plan with your business's name printed on the policy.

Partners

Partners have an additional step to consider.

The insurance policy may be held by the partnership or by the individual partner.

If the partnership pays the premiums, those amounts are generally reported to the partner as guaranteed payments and included in the partner's gross income.

If the policy is in the partner's name and the partner pays the premiums personally, the partnership generally needs to reimburse the partner and properly report those amounts as guaranteed payments.

Simply paying a personal health insurance bill and never running it through the partnership can jeopardize the self-employed health insurance deduction.

S Corporation Owners

This rule is particularly important for S corporation shareholders who own more than 2% of the corporation.

The health insurance policy can generally be in either the S corporation's name or the shareholder's name.

But the premiums need to be handled correctly through the corporation.

The S corporation generally must either pay the premiums directly or reimburse the shareholder for them and then report the premiums as taxable wages in Box 1 of the shareholder's Form W-2.

If a more-than-2% S corporation shareholder simply pays the health insurance premiums personally and never runs them through the S corporation and W-2, the shareholder can lose the self-employed health insurance deduction.

That's an easy mistake to make—and potentially an expensive one.

Test #2: Were You Eligible for Health Insurance Through an Employer?

This is probably the rule most likely to surprise self-employed taxpayers.

You generally can't claim the self-employed health insurance deduction for any month in which you were eligible to participate in a subsidized health plan maintained by an employer.

Notice the word eligible.

You don't necessarily have to enroll in the employer's plan for it to create a problem.

What If My Spouse Has Health Insurance Through Work?

This is where many self-employed taxpayers get caught.

Suppose you own a business and purchase health insurance through the Marketplace.

Your spouse's employer also offers a subsidized family health plan that you're eligible to join. You decide you prefer your Marketplace policy, so you decline the employer coverage.

Can you deduct your Marketplace premiums as self-employed health insurance?

Potentially not.

Eligibility for the subsidized employer plan can disqualify the self-employed health insurance deduction for those months even though you declined the coverage and paid for your own policy instead.

The rule can apply to coverage available through:

• your own employer if you have a W-2 job in addition to your business;
• your spouse's employer;
• an employer of your dependent; or
• an employer of a child who was under age 27 at the end of the year.

So before assuming your privately purchased insurance is deductible, look at what employer-sponsored coverage was available to your family.

What If Employer Health Insurance Was Available for Only Part of the Year?

There's some good news here.

The eligibility test is generally applied month by month.

Suppose your spouse works for an employer offering qualifying subsidized family coverage from January through June. Your spouse leaves that job at the end of June, and the employer coverage is no longer available beginning in July.

The fact that you were ineligible for the self-employed deduction during the first part of the year doesn't necessarily eliminate the deduction for the entire year.

You may be able to claim qualifying self-employed health insurance premiums for the months when the employer plan was no longer available.

This is one reason midyear job changes, marriage, divorce and changes in employer benefits deserve special attention when calculating the deduction.

Test #3: Is It Actually Medical Care Insurance?

The third test sounds obvious until you look at all the products marketed as "insurance."

Not every insurance policy related to your health qualifies as medical care insurance for this deduction.

For example, premiums generally don't qualify when they're for policies providing benefits such as:

• life insurance;
• disability or loss-of-income coverage;
• accidental death and dismemberment coverage; or
• fixed-benefit hospital indemnity coverage that pays a predetermined amount rather than reimbursing medical care.

A policy might provide money after an illness or injury and still fail to qualify as medical care insurance for purposes of the self-employed health insurance deduction.

It's the nature of the coverage—not simply the word "insurance" on the policy—that matters.

What About Accident or Sports Insurance for My Child?

Parents sometimes purchase school athletic or sports accident policies for their children.

Those policies frequently operate as fixed-benefit accident coverage rather than traditional medical insurance.

If that's the case, the premiums generally won't qualify for the self-employed health insurance deduction.

There's also the separate requirement that the qualifying plan be established under your business.

So don't automatically add every insurance premium associated with medical risk to your self-employed health insurance calculation.

Is There a Limit on the Self-Employed Health Insurance Deduction?

Yes.

Even after the insurance passes all three tests, the deduction is limited by the income from the particular trade or business under which the insurance plan was established.

In simple terms, your health insurance deduction can't exceed the qualifying earned income from that business.

This can become particularly important when you own multiple businesses.

What If I Own Two Businesses?

Suppose you own two separate businesses and have health insurance associated with each.

You generally can't take excess profit from one business and use it to support health insurance premiums attributable to the other.

The calculation is tied to the specific trade or business under which the plan was established.

If one business operates at a loss, that business generally doesn't provide the earned income necessary to support a self-employed health insurance deduction for a plan established under it.

This is another reason entity structure and the way expenses are assigned among related businesses can matter.

What If I Buy Health Insurance Through the Marketplace?

Marketplace insurance can create an additional layer of complexity because of the Premium Tax Credit.

The self-employed health insurance deduction reduces adjusted gross income.

But adjusted gross income can affect the amount of Premium Tax Credit for which you're eligible.

And the Premium Tax Credit affects how much of the health insurance premium you actually paid yourself.

That creates a circular calculation:

Your health insurance deduction affects your Premium Tax Credit, while your Premium Tax Credit affects your health insurance deduction.

The IRS provides calculation methods for resolving this interaction, but this is one situation where simply entering the amount you personally paid for Marketplace coverage and calling it your deduction can produce the wrong result.

What Happens to Health Insurance Premiums I Can't Deduct?

Failing to qualify for the self-employed health insurance deduction doesn't necessarily mean the premiums have no tax value whatsoever.

Health insurance premiums that aren't deductible as self-employed health insurance may potentially be included with your medical expenses as an itemized deduction on Schedule A.

However, Schedule A medical expenses are subject to a significant limitation: generally, only qualifying medical expenses exceeding 7.5% of adjusted gross income are deductible.

You also have to itemize rather than take the standard deduction for the Schedule A deduction to provide a benefit.

So while there may be a fallback, the above-the-line self-employed health insurance deduction can be considerably more valuable.

Why Is the Self-Employed Health Insurance Deduction So Valuable?

Unlike an itemized medical deduction, the self-employed health insurance deduction reduces adjusted gross income.

That matters because adjusted gross income can influence other parts of your tax return.

Depending on your situation, lowering AGI may affect deductions, credits and other tax provisions that are limited or phased out as income increases.

And because you don't need to itemize to claim the self-employed health insurance deduction, it can provide a tax benefit even when you take the standard deduction.

Before You Claim the Deduction, Ask These Three Questions

If you're self-employed and paying health insurance premiums, don't stop at asking whether you wrote the check.

Ask:

1. Was the insurance properly established under the business?
2. Were you eligible for subsidized employer-sponsored coverage during any of the months you're claiming?
3. Does the policy actually qualify as medical care insurance?

Then determine whether the income from the applicable business is sufficient to support the deduction and whether Marketplace premium tax credits affect the calculation.

S Corporation Owners Should Check Their W-2 Before Year-End

If you're a more-than-2% S corporation shareholder, there's one takeaway that's especially important:

Don't wait until you're preparing your tax return to discover that your health insurance premiums were never handled through payroll.

The S corporation's payment or reimbursement of qualifying premiums and the proper W-2 reporting are essential pieces of the deduction.

This is exactly the kind of issue that's much easier to address while the tax year is still open than after payroll forms have already been prepared.

Let Ken-Mar Tax Help You Get the Deduction Right

The self-employed health insurance deduction can be valuable, but the rules change depending on whether you're a sole proprietor, partner or S corporation shareholder—and seemingly unrelated facts, such as access to your spouse's employer health plan, can change the result.

Ken-Mar Tax can help you determine which premiums qualify, whether your business has handled them correctly and how the deduction interacts with the rest of your tax return.

If you're paying thousands of dollars a year for your family's health insurance, it's worth making sure you're getting every tax benefit you're legitimately entitled to receive.