3.5 MIN READ
We’ve previously written about how to pay yourself depending on your entity type. As a quick refresher, if you’re a single member LLC, you take draws. Partners in a multi-member LLC take distributions and/or guaranteed payments (if that is set in your operating agreement). And S-Corp owners are paid a reasonable and commensurate salary. If all of this sounds foreign to you, be sure to review our previous blog post, Are You Paying Yourself Properly?
What we didn’t get into on that last post is how to handle reporting of and paying for certain benefits such as health insurance.
As a small business owner, health, dental, vision, and long-term care insurance premiums are deductible for you and your family. Where that deduction is taken depends on your entity type.
The introduction of the Affordable Care Act changed certain requirements dictating how health insurance benefits can be paid. For sole proprietors, owners can pay for their insurance premiums directly. When recording the cost of health insurance, create a separate ‘draw’ item in the equity section of the balance sheet.
Health insurance premiums for sole proprietor owners don’t affect the bottom line of your business. They are a personal deduction on form 1040 Schedule 1, meaning you pay self-employment taxes on the total amount of income generated, but don’t pay income & FICA taxes on the amount of premiums deducted. Yet there are a couple of caveats.
First, the premiums are deductible only to the extent for which you have business income. Meaning if you have a net loss that year, none of the health insurance deduction will be allowed on form 1040 Schedule 1. But whatever amount is excluded from Schedule 1 due to an income limitation can still be taken as an itemized deduction.
Second, you may not take the self-employed health insurance deduction if you are eligible to participate in a health insurance plan maintained by your employer or your spouse’s employer.
Sole proprietors/single member entities have it pretty simple. With partnerships and S-Corps, things get a bit more complicated. Both of these entities have favorable tax treatment of health insurance premiums paid by the business on behalf of the owner. Let’s take a closer look at partnerships first.
If the partnership pays for the plan on behalf of the business owner, the insurance premium is deductible as a guaranteed payment to the owner, directly affecting the bottom line.
This has a couple of key impacts:
- The owner will have the amount of premiums included in their K-1 as guaranteed payments, as well as any other payments to the partner outlined in their operating agreement.
- Your guaranteed payments, health insurance included, are still subject to self-employment (SE) tax.
- You deduct the amount of health insurance premiums paid on Schedule 1 of Form 1040, so you don’t pay income tax and FICA taxes on the amount of premiums paid.
For recording purposes, we suggest you create a sub-account of guaranteed payments called “health insurance” to house these expenses. Having this separate will save time and money when it comes time to prepare your taxes.
Yet again, S-Corps are slightly different. As an S-Corp owner, whether or not you have multiple partners, you need to pay yourself a salary. You are an employee of your business after all.
Even though you are considered an employee, and your wages and benefits are deductible as expenses just as with any other employee, there are certain rules for 2% or more shareholders.
Health insurance premiums paid on your behalf by your business must be included in box 1 of your W-2. This is to include all insurance premiums, not just health insurance. Effectively, this increases the salary you report on Schedule 1 of Form 1040 but decreases self-employment income.
What does this mean? Income tax will be calculated on the total amount of income earned, including wages and insurance premiums included in wages. Unlike the other entities discussed previously, the real benefit here is that you won’t be paying SE tax on premiums.
Premiums are still deductible on Schedule 1 of form 1040, as long as the business directly pays for insurance benefits on the owner’s behalf and the policy is established by the business, not by the owner personally.
You may ask, “Well what if I hire my spouse to work at the business and have the business pay for their family insurance policy? I won’t have to include this in wages, right?”
Think again.The IRS is already on to you! Spouses of S-Corp owners are considered to be owners due to the IRS’s attribution rules, therefore you can’t hire them to get favorable untaxed insurance benefits for you and your family.
When recording these expenses, be sure to create an account for wages/salary called S-Corp owner’s salary. Under that, create a sub-account called S-Corp owner’s insurance premiums. This will allow for easy tracking, easy W-2 preparation, and time savings when preparing your returns.
Did any of this strike a chord and get you thinking about how you are handling benefits? Be sure to reach out. We can review your books and help you get back on track.