8804 / How is health insurance coverage taxed for S corporation shareholders?

A shareholder-employee who owns more than 2 percent of the outstanding stock or voting power of an S corporation (based on direct ownership as well as attributed ownership) will be treated as a partner, not an employee (see Q 8803 for the rules applicable to partners).¹ Therefore, accident and health insurance premium payments for more-than-2 percent shareholders paid in consideration for services rendered are treated as guaranteed payments made to partners. The result is that an S corporation can deduct premiums under IRC Section 162 and a shareholder-employee must include premium payments in income under IRC Section 61. The shareholder-employee cannot exclude them under IRC Section 106, but may deduct the cost of the premiums to the extent permitted by IRC Section 162(l), as discussed in Q 8803.² The IRS released a CCM clarifying that this remains the case even if the 2-percent shareholder-employee is treated as a 2-percent shareholder via the family attribution rules.³

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Planning Point: The IRS has released a set of frequently asked questions based upon the regulations governing the new Section 199A deduction for pass-through entities, such as S corporations. The FAQ provides that health insurance premiums paid by the S corporation for a greater-than-2-percent shareholder reduce qualified business income (QBI) at the entity level (by reducing the ordinary income used to calculate QBI). Similarly, when a self-employed individual takes a deduction for health insurance attributable to the trade or business, this will be a deduction in determining QBI and can reduce QBI at the entity and individual levels.⁴

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With respect to coverage purchased by an S corporation for employees who do not own any stock and for shareholder-employees who own 2 percent or less of the outstanding stock or voting power, the same rules apply as in any other employer-employee situation.

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1.  IRC § 1372.

2.  Rev. Rul. 91-26, 1991-1 CB 184.