As we approach year-end, employee-shareholders who own more than 2% of the shares in an S corporation need to adjust their W2 compensation to reflect the addback of health insurance premiums paid by the corporation on their behalf.  The shareholder then takes an above the line deduction on their individual income tax return to properly claim the deduction for self-employed health insurance premiums.  Guidance issued under  The Affordable Care Act has created a potential issue related to this specific W2 addback for 2% shareholders in S Corporations.

The issue arises when a 2% shareholder does not participate in a group health insurance plan but instead purchases their own personal insurance policy outside of the company and has the corporation reimburse the premiums and adjust the Form W2 accordingly so the deduction can be taken on the taxpayer’s individual income tax return.  From an income tax standpoint, a position can be taken that the policy qualifies for the deduction.  However, there is a risk that under this scenario that the employer is not complying with the ACA and could be subject to a $100 per day penalty for such a reimbursement policy.   The $100 per day ACA penalty is not a deductible business expense thereby making its impact more severe.  There will likely be more guidance in the future as this issue continues to develop.  In order to maintain the above the line income tax deduction on the shareholder’s individual income tax return and remain ACA compliant, it is important that the shareholder and the corporation carefully follow the rules associated with the self-employed health insurance premium deduction under IRC Sec. 162(l).  This is likely a defendable position as the law and current guidance thereunder are silent on the ACA’s impact on IRC Sec. 162(l).

The IRS has issued Notice 2008-1, which establishes the criteria for 2% shareholders to qualify for a deduction for self-employed health insurance premiums under IRC Sec. 162(l)(5). The Notice provides that a “plan providing medical care coverage” is “established” by the S corporation (and thus allows the shareholder to take the IRC Sec. 162(l)(5) deduction) if:

  • The S corporation makes the premium payments for the health insurance policy covering the 2% shareholder (and his or her spouse or dependents) in the current taxable year; or
  • The 2% shareholder makes the premium payments and furnishes proof of premium payment to the S corporation and then the S corporation reimburses the 2-percent shareholder for the premium payments in the current taxable year.

If the health insurance premiums are not paid directly by the S corporation or reimbursed to the employee by the S corporation and included in the 2% shareholder’s gross income, a plan providing medical care coverage for the 2% shareholder is not established by the S corporation and the 2% shareholder is not allowed the deduction under IRC Sec. 162(l).

If the S corporation has more than one full-time employee and has a qualified group health insurance plan, the company may continue the W-2 addback for 2% shareholders to take the health insurance premiums paid for or reimbursed by the company as an above the line deduction on their individual income tax return.