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A Post for S-Corp Owners

Confused About S-Corp Reimbursement Arrangements?

Everybody seems to be confused about S-Corp shareholder participation in medical reimbursement plans. There is also confusion about S-Corp shareholders deducting health insurance costs and the steps that need to be taken to allow the deduction. This post is for S-Corp shareholders, why you absolutely want to participate in your business’s reimbursement plan and how to achieve the same tax advantage as your employees.

Health reimbursement arrangements are all actually a version of a Self Insured Medical Reimbursement Plan, codified in 26 CFR 1.105-11. The different acronyms associated with the plans, HRA, HRP, MRP, MERP, HIRP, et al, are not exactly legal terms, even though you will find them in Treasury guidance, these are acronyms coined by administrators, brokers, insurance carriers and even the government to distinguish them from one another. They can have different plan structures and eligible expense exclusions depending on how they are offered, as an integrated plan or a stand alone plan, which have different regulatory requirements. In all structures, and acronyms, IRC Section 106 allows the value of the self-insured medical reimbursement plan to be tax-free to employees, unless you are an owner employee.

The IRS has specific rules related to the inclusion of fringe benefits as income for Sole proprietors, partnerships and S-Corp shareholders. IRS Notice 2008-1 does a fair job of outlining these special rules.

In February of 2015 the IRS released IRS Notice 2015-17 which contained guidance on the application of Code 4980D (the tax applied to non-compliant plans) to health reimbursement arrangements. It also provided some clear guidance on S-Corp shareholder participation. Here is what the notice said:

 The Treasury Department and the IRS are also considering whether additional guidance is needed on the federal tax treatment of 2-percent shareholder-employee healthcare arrangements. However, unless and until additional guidance provides otherwise, taxpayers may continue to rely on Notice 2008-1 with regard to the tax treatment of arrangements described therein for all federal income and employment tax purposes.

As of this writing the IRS has not released any guidance or proposed regulations and taxpayers may continue to rely on the guidance provided in Notice 2008-1. Perhaps this is where the confusion takes root. Notice 2008-1 states that:

Accident and health insurance premiums paid or furnished by an S corporation on behalf of its 2-percent shareholders in consideration for services rendered are treated for income tax purposes like partnership guaranteed payments under § 707(c) of the Code. Rev. Rul. 91-26, 1991-1 C.B. 184. An S corporation is entitled to deduct the cost of such employee fringe benefits under § 162(a) if the requirements of that section are satisfied (taking into account the rules of § 263). 

The underlined text, indicating that the S-Corp is to take the deduction, is likely to be confusing. In 2008, when the guidance was published, this deduction was typically taken on the Schedule SE (Form 1040), beginning in tax year 2011, this deduction was no longer allowed on Schedule SE, you now had take it on Form 1040, line 29.

Therefore, a shareholder owning more than 2 percent of the outstanding stock of an S corporation with wages from the corporation reported on Form W-2 who is paying for medical, dental or long-term care insurance can take a deduction on line 29 of their 1040, a frontpage, non-itemized deduction, as long as the insurance plan has been established under your business. Notice 2008-1:

A 2-percent shareholder-employee in an S corporation, who otherwise meets the requirements of section 162(l), is eligible for the deduction under section 162(l) if the plan providing medical care coverage for the 2-percent shareholder-employee is established by the S corporation. Rev. Rul. 91-26, 1991-1 C.B. 184.

In most cases where this is a question the S-Corp does not provide group health insurance, the shareholder has an individual health insurance policy in the shareholder’s name. In that case, if the policy is in the shareholder’s name and they pay the premiums themselves, the S corporation must reimburse the shareholder and report the premium amounts on Form W-2 as wages to be included in your gross income. Otherwise, the insurance plan will not be considered to be established under the business and the shareholder cannot take the line 29, self-employed health insurance deduction. IRS Tax Tip 2012-51 does a good job of explaining this.

S-Corp shareholder treatment in a self insured medical reimbursement plan

When an employee shareholder participates in a self insured medical reimbursement plan, specifically one designed to comply with the ACA’a “market reforms,” commonly referred to an a Healthcare Reimbursement Plan (HRP), the distributions should be made as an addition to net income with no FUTA, FICA or other tax withholdings. The distributions should be added to Box 1 of the shareholder’s W-2 at the end of the year but excluded from Box 3 (Social security wages) and Box 5 (Medicare wages and tips). The shareholder may then deduct the total amount spent on medical, dental and long-term care insurance for themselves and their family on line 29 of their 1040.

Participation in the business’s reimbursement plan ensures the employee shareholder satisfies the IRS requirement of having the insurance established under the business. This information is also applicable to partners with net earnings from self-employment reported on Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc., box 14, code A.


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