Estimates peg health insurance premium increases for 2008 at about 8.7%, on average. This is more than double the 4.1% Consumer Price Index increase for 2007.

Escape hatch: One of the key ways to make health coverage affordable for sole proprietors and business owners is through tax breaks.

Problem: Business owners, other than shareholders in C corporations, cannot enjoy company-paid health coverage on a tax-free basis. But they can arrange coverage in such a way that they maximize their deduction opportunities. Here’s how…

OWNER’S DEDUCTION

Rank-and-file employees who have their medical premiums paid by their employer are not taxed at all on this fringe benefit. Business owners aren’t so lucky. They can deduct the cost of their premiums, but only as a deduction from gross income…

  • Self-employed individuals. The business cannot deduct the owner’s premiums, even if the company foots the bill. This means that the owner effectively pays self-employment tax on the cost of the premiums. For example, say a sole proprietor nets $100,000 from the business and pays $10,000 for personal health coverage. He/she deducts the $10,000 on page one of Form 1040 as an adjustment to gross income, but he pays self-employment tax on the $100,000 reported on Schedule C — not on the true net of $90,000.

  • S corporation shareholders. Shareholders owning more than 2% of their S corporations are treated the same as self-employed individuals when it comes to deducting health coverage. They cannot enjoy tax-free health coverage. Like self-employed individuals, their personal coverage is deductible by the shareholder as an adjustment to gross income. (Premiums for rank-and-file employees are deductible by the S corporation.)

    • Careful: If an S corporation is owned by a single shareholder who wants health coverage, it is important to follow IRS rules to ensure this deduction from the shareholder’s gross income. To qualify, the corporation must pay the premiums, or reimburse the shareholder for paying the premiums, and the amount must be included in the shareholder’s wages on his W-2 form. It is not essential that the corporation obtain the policy in the company’s name.

    Trap: If the shareholder pays the premiums without reimbursement, he can deduct them only as an itemized medical expense (not as a fully deductible adjustment to gross income).

    COVERING OWNER’S SPOUSE

    A business owner whose spouse works for his company can transform a nonbusiness deduction into a fully deductible business write-off. How? The business can provide coverage for employees, their spouses, and dependents. If so, then business owners’ coverage is part of the employees’ benefit (spousal coverage) — it’s a business deduction and tax free to employees and their spouses (the owners).

    Opportunity: Business owners can expand coverage beyond amounts covered by insurance. Companies can use medical reimbursement plans to pay for a fixed dollar amount (set by the company) — it’s a deductible business expense and tax free to the employee (the owner’s spouse). However, a number of Tax Court cases over the past several years show that there’s a right way and a wrong way to do this.

    Right way: The company adopts a medical reimbursement plan, setting forth the terms and conditions for reimbursement (e.g., the spouse-employee must work a set number of hours each week to qualify for this medical benefit). The company must disburse the money to the spouse-employee upon demonstrating that medical expenses not covered by insurance have been incurred.

    Wrong way: The company disburses funds to the owner to cover the spouse-employee’s medical costs.

    If the company buys a policy, it must be in the name of the employee (the spouse) and not in the employer’s name.

    SAVING EVEN MORE

    Companies can use a variety of strategies beyond traditional health coverage to pay their health-care costs.

    Strategy 1: Health savings accounts(HSAs). Owners can contribute to a personal health savings account on a tax-deductible basis if they are covered by a high-deductible (low-cost) health plan. To qualify…

  • The insurance must have a minimum deductible under the policy of $1,100 for self-only coverage ($2,200 for family coverage).

  • The owners can have no other health coverage for themselves. They can, however, carry their own policies (and make their own HSA contributions) where a spouse has his own coverage through a separate employer.

  • The limit on annual contributions to an HSA in 2008 is $2,900 for self-only coverage ($5,800 for family coverage). Those who will be at least 50 years old by year-end can add another $900 for 2008.

    • Note: If the company makes the contribution to the owner’s HSA, it deducts it. For example, if an S corporation carries a high-deductible health plan for its employees and contributes to their HSAs, the corporation deducts the contributions.

    Strategy 2: State medical plans. Some states offer certain self-employed individuals and business owners the opportunity to obtain coverage through a state-sponsored plan. Examples…

  • Arizona offers a plan for uninsured sole proprietors and small businesses (those with fewer than 50 employees).

  • Maine has DirigoChoice for sole proprietors and small employers, regardless of income.

  • New York has Healthy NY, which offers coverage to sole proprietors and small employers who are New York state residents and meet certain income and other tests.

    • Important: Self-employed people are not eligible to participate in flexible spending accounts or health reimbursement accounts.

    Related Articles