S Corp Shareholder Health Insurance Rules: How More-Than-2-Percent Owners Must Handle Premiums and Deductions

Understanding S Corp shareholder health insurance rules is essential for owners who hold more than 2 percent of the company. These shareholders are not treated the same as regular employees when it comes to fringe benefits, and health insurance is one area where the IRS applies a unique set of requirements. If premiums are not paid and reported correctly, both the corporation and the shareholder can lose valuable tax benefits. Knowing the rules helps ensure proper compliance and maximizes the intended deduction.

Under IRS guidelines, a more-than-2-percent S corporation shareholder cannot receive employer-provided health insurance on a tax-free basis. Instead, the S corporation must either pay the health insurance premiums directly or reimburse the shareholder for premiums paid out-of-pocket. Once the payment occurs, the cost must be included in the shareholder’s Form W-2 as taxable wages. This wage inclusion is a key component of S Corp shareholder health insurance rules because it changes the nature of the benefit from a tax-free fringe benefit to taxable compensation.

Although the premiums increase taxable wages, the shareholder may take a self-employed health insurance deduction on their individual tax return. The deduction is allowed only if the plan is considered established by the S corporation and the shareholder has adequate earned income from the business. In many cases, this deduction offsets the W-2 wage inclusion, resulting in a tax outcome similar to what a self-employed individual would receive.

Accurate reporting remains critical. The premiums included in wages should appear in Box 1 of Form W-2 but not in Boxes 3 or 5. This ensures the amount is subject to income tax but excluded from Social Security and Medicare taxes. If the corporation fails to include the premiums in the W-2, the shareholder cannot claim the self-employed health insurance deduction, and the corporation’s own deduction may be challenged.

The policy must also qualify as an S-corporation-established plan. This typically requires either direct payment of premiums by the corporation or a timely reimbursement arrangement. If the corporation does not reimburse the shareholder in the same tax year, the plan may not qualify, leaving the shareholder without a deduction.

The IRS rules governing more-than-2-percent shareholder health insurance can be detailed, but when followed correctly, they allow owners to receive coverage while maintaining valuable deductions. For S corporations with several shareholders, it is important to evaluate how premiums are allocated through wages so each owner understands the tax impact. A clear understanding of S Corp shareholder health insurance rules helps ensure compliance, avoid costly mistakes, and support better tax planning for all owners involved.

The information provided in this blog post is intended for general informational purposes only and should not be construed as legal or tax advice. While every effort has been made to ensure the accuracy of the information, tax laws and regulations are subject to change, and individual circumstances may vary. For personalized advice and to ensure compliance with current tax laws, it is strongly recommended that you consult with a qualified tax professional, financial advisor, or legal counsel. The author and publisher of this blog assume no responsibility for any errors or omissions, or for any actions taken based on the information contained herein.