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Self-employed health insurance deduction 2016

Entrepreneurs need to keep an eye on changing tax code

Self-employment and entrepreneurship are a dream for many people, and Obamacare has made that option easier to pursue, thanks to guaranteed-issue coverage, premium subsidies, and Medicaid expansion. For entrepreneurs who don’t have access to a spouse’s group health insurance plan, being self-employed usually means purchasing a policy in the individual health insurance market.

And for those who are used to having an employer cover all or most of the premiums on a group plan, paying for an individual policy can induce a bit of sticker shock. This was particularly true prior to 2014, when the self-employed had to pay the full premium for an individual policy. But thanks to the ACA’s premium tax credits, many self-employed Americans are now getting help paying for their coverage.

In addition to the premium tax credits, there are other ways that the self-employed can save a few dollars when it comes to healthcare. One obvious place to look is on their tax forms, but one look isn’t enough: federal deductions for health insurance change regularly, so keep up with code changes.

For 2016 tax returns, the self-employed have several deductions and tax credits to utilize:

Deduction for self-employed isn’t new

If you buy your own health insurance, you should definitely know about the long-standing health insurance premium deduction for the self-employed.

Congress implemented a 25 percent deduction for self-employed health insurance premiums in 1987 and made it permanent in 1994. The self-employed received even better news in 2003 when premiums became 100 percent deductible.

The deduction – which you’ll find on Form 1040, Line 29 – allows self-employed people to reduce their adjusted gross income by the amount they pay in health insurance premiums during a given year. You’ll find the deduction on your personal income tax form, and you can file for it if you were self-employed and showed a profit for the year.

If you’re also eligible for a premium tax credit (premium subsidy), there are two methods that the IRS will let you use to determine your deduction and your tax credit.

You can’t take the premium deduction if you were eligible for a group insurance from your or your spouse’s employer.

The ACA and more-than-2% S-corp shareholders

Since 2008, more-than-2% shareholders of an S-corp have been allowed to buy individual health insurance in their own name, and then get reimbursed by the S-corp.  The premiums were included on the shareholder’s W2, and then the shareholder was allowed to deduct the premiums on the first page of Form 1040, resulting in a lower AGI (see example 4 on page 4 of the IRS regulation from 2008).

But the ACA’s ban on employers reimbursing employees for individual health insurance premiums seemed to run counter to this provision, depending on how many S-corp shareholders were involved. This explanation from the IRS (updated December 2014) explains that a shareholder who is the sole corporate employee in an S-corp may continue to be reimbursed from the S-corp for individual health insurance (and this is clarified in Notice 2015-17, described in more detail below).

But until February 2015, the IRS had not directly addressed the issue of multiple more-than-2% shareholders, and the concern was that if there was more than one 2% shareholder, the corporation could run afoul of the market reforms in the ACA and be subject to significant penalties ($100 per day, per reimbursed employee).But at the time, most accountants—and the IRS attorney I spoke with in January 2015—agreed that if there were multiple shareholders or employees (including spouses), it was best to

At the time, most accountants—and the IRS attorney I spoke with in January 2015—agreed that if there were multiple shareholders or employees (including spouses), it was best to err on the side of caution and not get reimbursed by the S-corp if the shareholders were covered by individual (ie, non-group) health insurance.

In February 2015 however, the IRS released Notice 2015-17, and it was very good news for more-than-2% S-corp shareholders, as well as any other small business subject to the market reforms that prohibit the reimbursement of individual insurance premiums. Several provisions in Notice 2015-17 are applicable if you’re self-employed:

  • The penalties for not complying with the ban on reimbursing individual health insurance were delayed until June 30, 2015, as long as the business has fewer than 50 full-time equivalent employees. Originally, the penalties were applicable as of January 1, 2014.
  • More-than-2% shareholders were exempt from the ACA’s market reforms in 2015, and possibly beyond, until the IRS releases further guidance on this issue (although if they have employees who are not more-than-2% shareholders, those employees cannot be reimbursed for individual health insurance). In March 2016, the IRS confirmed that no additional guidance had been issued yet and that Notice 2008-1 was still applicable as far as the tax treatment of health insurance for more-than-2% shareholders. The details are incorporated on the current IRS page about more-than-2% S-Corp shareholders. As of April 2017, the page notes that the IRS is still “contemplating publication of additional guidance on the application of the market reforms to a 2-percent shareholder-employee healthcare arrangement,” but notes that no additional guidance has yet been published.
  • If a shareholder has an individual plan that covers a spouse and the spouse is also employed by the corporation, the reimbursement arrangement is treated as if there is just one covered employee — thus the market reforms that would have prohibited reimbursement of premiums do not apply (the IRS has confirmed that this is a permanent rule). This is particularly good news for mom-and-pop shops that have two shareholders who are married to each other; if they have a single individual health insurance policy, they can continue to have the corporation reimburse their premiums, and then deduct them on their 1040 per Notice 2008-1.

HSAs allow insureds to pay for medical expenses with pre-tax dollars

Although being self-employed means that there’s no employer footing the bill for health insurance, it also gives entrepreneurs a lot of flexibility in terms of what type of health insurance they purchase. One popular option is an HSA-qualified high deductible health plan (HDHP).

Although some people have expressed concerns that market reforms under the ACA would be incompatible with HSAs, that has not proved to be the case, and HSA-qualified plans are still a popular choice in the individual market. Indeed, the standardized plan options that HealthCare.gov made available for 2017 are slated to be expanded for 2018 to include an HSA-qualified plan design.

Coverage under an HDHP makes the insured eligible to open an HSA and make pre-tax contributions that can be used later to pay for medical expenses. In 2016, the contribution limits were $3,350 for a single individual and $6,750 for a family.  For 2017, the contribution limit for a single individual has increased to $3,400. For a family, it remains $6,750.

The contribution is deducted “above the line” on the 1040, which means it’s available to filers regardless of whether they itemize deductions. And although the money can be withdrawn without penalties or taxes to pay for qualified medical expenses, some insureds choose to treat their HSAs as secondary retirement accounts, with tax implications similar to traditional IRAs: contributions are tax deductible and distributions during retirement are taxed as income.

The future of the ACA under the Trump Administration is uncertain. In March 2017, House Republicans pulled their proposed legislation, the American Health Care Act, before it reached a vote on the floor of the House, after they had determined that it did not have enough Republican support to pass (Democrats were universally opposed to the legislation, as it would have rolled back many of the ACA’s reforms and resulted in the uninsured population growing by 24 million people over the next decade).

For the time being, the ACA remains intact, and although some Republican lawmakers are pushing to continue the repeal/replace effort, others are calling for the party to move on to the rest of their agenda. If Republican lawmakers do end up advancing legislation to modify or replace the ACA, it’s likely that HSAs would be enhanced or expanded, as most of the replacement proposals that Republicans have put forth over the last few years include an increased emphasis on HSAs.

ACA tax credits make individual health insurance more affordable

Thanks to the ACA, federal tax credits (subsidies)—obtained via the exchanges—are helping many families subsidize the purchase of individual health insurance. The tax credits are great for the self-employed, who had to foot the entire bill for their health insurance prior to 2014. Employees who get employer-sponsored health insurance typically enjoy a substantial subsidy in the form of pre-tax premiums and employer contributions to the premium. The ACA makes similar subsidies available for many self-employed people.

The tax credits are available to households with incomes under 400 percent of the federal poverty level (FPL), as long as the enrollees do not have access to employer-sponsored health insurance that is considered affordable (and as long as the unsubsidized cost of coverage is above the level that the IRS considers affordable). For coverage effective in 2017, the 2016 poverty level is used, and the upper annual income threshold for subsidy eligibility is $47,520 for a single individual and $113,760 for a family of five (in the continental US; Alaska and Hawaii have higher poverty level guidelines). For 2016 tax returns being filed in 2017, keep in mind that the 2015 poverty level guidelines were used to determine tax credits for 2016 coverage.

The relatively high income limits mean that premium tax credits are widely available: of the 11 million people who had effectuated coverage with private health plans through the exchanges as of March 2016, nearly 85 percent qualified for premium tax credits. Nationwide, the average premium subsidy in 2016 was $291 per month.

The tax credits can be paid directly to health insurance carriers on a monthly basis to reduce the amount that insureds have to pay for their coverage, which is the most popular option. But it’s not the only choice: people can opt to pay full price for a plan purchased through the exchange, and then claim the tax credit in full on their tax returns; either way, the total amount received will be the same.

For eligible self-employed people, the tax credits make individual health insurance significantly more affordable than it would otherwise be. And since the ACA also did away with medical underwriting in the individual health insurance market, people who avoided entrepreneurship in the past because of pre-existing health conditions can now become self-employed without having to worry about being ineligible to purchase health insurance.

One last write-off to consider

If you face high medical bills and itemize your deductions, you might be able to deduct some of your medical expenses. The deduction – found on Schedule A of your income tax return – covers a wide range of medical expenses, and also includes premiums you pay for health insurance or qualified long-term care. You can’t double deduct, though — if you deduct your health insurance premiums under the self-employed health insurance deduction explained above, you can’t include them in your itemized medical expenses.

And you can only deduct expenses in excess of 10 percent of your adjusted gross. The threshold used to be 7.5 percent (through 2012), and for filers who are at least 65 years old, medical expenses that exceed 7.5 percent of adjusted gross income could still be deducted through the end of 2016 (for 2016 tax returns filed in 2017).

But starting in 2017 (for tax returns filed in early 2018), all filers are limited to deducting only medical expenses that are in excess of 10 percent of their AGI, which can be a hard target to hit unless you’re dealing with a significant illness or injury.

Still, it’s one more good reason to keep track of your medical bills and health insurance premiums – just in case.

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