‘Health Insurance’ for the purposes of this discussion, refers to any health, dental and long-term care insurance premiums that are paid for you, your spouse, your dependents and/or children under the age of 2 (even if those children are not dependents on your income tax return). Medicare premiums paid to obtain health insurance are also included.
OK, so here is the scenario: you are an LLC member and your LLC pays the health insurance premiums for you and your family. You want to know if, how, when and where you can deduct these expenses on your personal tax return.
Before we get to that you’ll need to identify what ‘type’ of LLC you are a member of and whether you are an active or passive member. Then we’ll explain what is and what is not deductible.
What are the different types of LLCs?
1. LLC treated as a partnership – Federal filing form: 1065
This is the default tax treatment for LLCs. LLCs treated as partnerships are flow-through entities for which IRS requires the filing of the federal form 1065. Members of partnership LLCs receive a K-1 to report their portion of income/(loss) to their personal tax return – whereupon that income/(loss) is reported on the members’ 1040.
2. Single Member LLC (SMLLC) – Federal filing form: Sch. C of your 1040
A single-member LLC is a disregarded entity for tax purposes i.e. a business entity not recognized by the IRS and is automatically treated as a sole proprietorship and reported on Sch. C of your 1040.
3. LLC treated as a Corporation – Federal filing form: 1120 or 1120S
For an LLC to be treated as a corporation, a change of entity type election must be made. There are 2 choices: C-Corp. or S-Corp. In either case, the LLC member is treated as an employee of the business and employment tax rules must be followed.
Am I an active or passive member?
If you ‘materially participate’ in the work of the business, you are an active member, if you don’t you are passive. (There are guidance and tests around this, one article documented here.) Active members of LLC partnerships are treated as ‘self-employed’. Passive members aren’t.
How do HEALTH INSURANCE PREMIUMS get treated?
1. Guaranteed payment to member on K-1
When an LLC is treated as a partnership, health insurance payments on behalf of members are treated as guaranteed payments and get reported to the partner on the member’s K-1. And thus, the premiums paid on their behalf are treated as income to the member. Even if the member pays the premiums from personal funds, the member must seek reimbursement from the partnership LLC or else the plan won’t qualify for premium deduction.
2. Health Insurance Premium Expense – Not taken on Sch. C, but on Line 29 of 1040
So here is some tricky stuff. The normal Single Member LLC files taxes as a sole proprietorship, using a Schedule C (or Schedule F for farming) on the member’s personal tax return (Form 1040). However, since an SMLLC is, by default, treated as self-employed, their health insurance premium expense is not to be reported on schedule C with the other expenses of the business but taken directly on line 29 of form 1040, as for a self-employed individual.
Tax treatment is the same for both Partnership LLC and SMLLC
For members of both LLCs treated as partnerships and as single member LLCs, the deduction for health insurance expenses is taken as an adjustment to income on page 1 of Form 1040 on line 29.
In order to use the deduction, it is important that your LLC is profitable. The health insurance deduction may not exceed the net profit from the business under which the health insurance premiums are paid. In the fancy words used by IRS this is called the “earned income limitation.”
“What do I do if I don’t have profits”?
If your LLC shows a loss for the year, you may still be able to take the deduction, but in a limited way. You may take the deduction on Schedule A under medical expenses your expenses are greater than 7.5% of your adjusted gross income (AGI).
Also, in both of the above cases, remember that “eligibility to deduct is determined month by month”. What does that mean? Let’s say you were employed during the first six months of a year and quit to start your own business. You effectively became ineligible for any employer-provided health plan for the last six months of the year because you left your job and started your own business. Technically speaking you became “self-employed” and are allowed to claim the deduction for premiums you paid for coverage during the second half of the year, not the first six months. The IRS calls this “the month by month eligibility rule”
3 (A). Health Insurance Premium Expense – LLC treated as an S-corp:
The S-corp gets to deduct the premiums paid as compensation paid to the shareholders / employees who own more than 2% of the S-corp i.e. the premiums are included in the salary paid. The S corporation must report the accident and health insurance premiums paid or reimbursed as wages on the 2-percent shareholder-employee’s Form W-2.
Tax treatment by a more than 2% shareholder of the S-corp:
For 2% S-corp shareholders the health insurance premium paid by the S-corp are included as wages on Form W-2 and then the 2% shareholder can deduct the health insurance premiums on Form 1040, line 29. Again, keep in mind, your health insurance deduction cannot be more than your wages from the S-corporation
However, nothing comes without strings attached from the IRS. As a amore-than-2% shareholder of an S-corporation, for you to qualify for the deduction you’re the plan must be “established” by the S-corporation.
What do we mean by an established plan?
The plan is considered established by the S-corporation even if the plan is in your own name provided:
- The corporation pays the premiums to the insurance company
- If you paid to the insurance company, the corporation reimburses you for the premiums
- The premiums are reported as wages on your Form W-2 and included on your individual income tax return.
Note: If you don’t qualify for an above-the-line deduction for premiums you paid out of your pocket, you can claim the premiums you paid on Schedule A as an itemized deduction). It is important that in order to qualify for the deduction (on Form 1040, line 29), the plan must be “established”by the S-corporation.
3 (B). Health Insurance Premium Expense – LLC treated as a C-corp:
The rules in this respect are:
- LLC shareholders that receive corporate tax treatment are not eligible to receive health insurance from the business unless they are bona fide employees.
- For premiums paid to bona fide employees the corporation takes the deduction on the corporate tax return on IRS Form 1120
- A corporation that provides non-employee shareholders with health insurance may not take the deduction on the corporate tax return
DIFFERENCES
The advantage of being a self-employed individual:
If an individual is not self-employed (or not a more-than-2% shareholder of an S-corporation) they do not get to deduct health insurance premiums on Form 1040, Line 29, instead, they get only the limited deduction for health insurance premiums along with other medical expenses as an itemized deduction on Schedule A greater than 7.5% of their adjusted gross income.
The self-employed get to deduct all health insurance premiums even if they don’t itemize deductions.
Conclusion: If you qualify, the deduction for self-employed health insurance premiums is a valuable tax break. With the rising cost of health insurance, a tax deduction can help mitigate a portion of the premium cost. And remember, health insurance premiums are not deductible on your Schedule C, your 1065 partnership income tax return, or your 1120S S-Corp. income tax return (if you were a shareholder owning more than 2% of the outstanding stock). The only time health insurance premiums are deductible by a corporation is when your company is incorporated as a C corporation.