S Corp Health Insurance Deduction Guide

Managing health insurance as an S corporation owner comes with unique rules that differ from standard employee benefits. Getting the payroll treatment right protects your health insurance deduction for S Corp shareholders and keeps you compliant with IRS requirements. Here's what you need to know about including health insurance premiums in your S Corp payroll.

Understanding S Corporation Health Insurance Requirements

S corporation shareholders who own more than 2% of the company face special rules for health insurance. The IRS requires that health insurance premiums paid on behalf of these shareholder-employees be included as taxable wages on Form W-2. However, these premiums receive favorable treatment since they're not subject to Social Security, Medicare, or unemployment taxes.

According to the IRS guidance on S corporation compensation, health and accident insurance premiums paid on behalf of a greater than 2% S corporation shareholder-employee are deductible by the S corporation and reportable as wages on the shareholder-employee's Form W-2, subject to income tax withholding. The key principle is straightforward: premiums must flow through payroll to qualify for the self-employed health insurance deduction S corporation owners can claim.

Who Qualifies as a 2% Shareholder?

Any shareholder who owns more than 2% of the S corporation's stock, either directly or through family attribution rules, falls under these requirements. Family members who work for the company are also subject to these rules if a more than 2% shareholder is a relative.

The attribution rules mean that spouses, children, grandchildren, and parents of 2% shareholders are treated as 2% shareholders themselves. Stock owned by family members is combined when determining the 2% threshold, and even indirect ownership through trusts or other entities can trigger these rules.

How to Add Health Insurance Premiums to Payroll

The S corporation must include health insurance premiums in the shareholder-employee's gross wages. Understanding the S Corp payroll tax impact helps employers manage this process effectively.

Step-by-Step Payroll Process

Start by adding the monthly premium amount as a separate pay item or earning type in your payroll system. Configure the earning type to be included in Box 1 for federal taxable wages and Box 16 for state taxable wages where applicable. Exclude the premium amount from Boxes 3 and 5, which report Social Security and Medicare wages.

Run payroll with the premium amount added each pay period, or add the annual total to the final payroll of the year. Verify that Box 14 includes the premiums with a label such as "SEHI" or "2% S/H Health Ins." This proper reporting ensures your S Corp health insurance deduction remains valid.

Payment Arrangements That Work

The IRS allows flexibility in how premiums are paid. The S corporation can purchase a policy in its own name and pay premiums directly. Alternatively, the shareholder can purchase individual coverage, and the S corporation reimburses those premiums through payroll.

Either arrangement works as long as the premiums appear on the W-2 as wages. The policy can be in the corporation's name or the shareholder's name without affecting the tax treatment for S corporation health insurance benefits.

The Tax Benefits of Proper Reporting

When premiums are correctly included in W-2 wages, shareholder-employees can claim the self-employed health insurance deduction S corporation rules allow on their personal tax returns. The deduction appears on Schedule 1, Line 17 of Form 1040 and reduces adjusted gross income.

The S corporation deducts the premium amount as officer compensation, while the shareholder-employee claims an above-the-line deduction that reduces taxable income. Neither the corporation nor the shareholder pays FICA taxes on the premium amount, and the deduction is available regardless of whether you itemize deductions. This favorable S corp payroll tax impact makes proper reporting worthwhile for startups and established businesses alike.

Common Mistakes to Avoid

Many S corporation owners lose valuable tax benefits due to payroll errors. The most damaging mistake is failing to add premiums to W-2 wages altogether. If premiums aren't included in your gross wages, the IRS considers the health plan not established by the employer, and the entire personal deduction for your health insurance for an S corporation gets disallowed.

Some payroll systems automatically add income to all wage boxes. You must verify that health insurance premiums are excluded from Social Security and Medicare wages in Boxes 3 and 5. Including premiums in FICA wages means both you and the S corporation overpay employment taxes. Additionally, the S corporation should not deduct premiums as a separate line item on Form 1120-S since the premiums become deductible through their inclusion in officer compensation.

How Venteur Simplifies Health Benefits Administration

For S corporations exploring alternatives to traditional group health insurance, we offer a comprehensive ICHRA platform at Venteur that handles the complexities of health benefits administration. The employer experience includes automated compliance features, flexible plan design, and seamless integration with payroll systems.

Whether you're a small or medium-sized business or an enterprise organization, our platform enables you to offer personalized health benefits while maintaining proper tax treatment for shareholder-employees. Brokers appreciate our streamlined approach, and employees get access to plans that fit their unique needs through an intuitive employee experience. With no setup fees or monthly minimums, Venteur makes quality corporate health insurance accessible for companies of all sizes.

Moving Forward with Confidence

Getting S Corp health insurance payroll right requires attention to detail, but the process becomes routine once you understand the requirements. Add premiums to W-2 wages in Box 1, exclude them from FICA taxes in Boxes 3 and 5, and claim the self-employed health insurance deduction S corporation shareholders are entitled to on your personal return. With proper setup, you'll maximize tax benefits while staying compliant with IRS rules.