Tax deductions and tax credits for the self-employed:
- The self-employed have several deductions and tax credits to utilize.
- For the self-employed, health insurance premiums became 100 percent deductible in 2003.
- The deduction that allows self-employed people to reduce their adjusted gross income by the amount they pay in health insurance premiums during a given year.
- If you have an S-corp, you should be aware of a 2015 notice regarding reimbursement for health premiums.
- HSAs allow the self-employed to pay for medical expenses with pre-tax dollars.
- For eligible self-employed people, the ACA’s tax credits make individual health insurance significantly more affordable.
- The self-employed may also be able to deduct some of their medical expenses, including premiums.
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 use the tax code to save a few dollars when it comes to healthcare. There are several deductions and tax credits that self-employed people can 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), you can only deduct the part of the premiums you pay yourself. That can get into some circular math, but 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. That includes eligibility for reimbursements via a Qualified Small Employer Health Reimbursement Arrangement (QSEHRA).
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).
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). As of February 2018, the IRS website confirms that Notice 2008-1 was still applicable as far as the tax treatment of health insurance for more-than-2% shareholders. 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 clarifies 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. This is particularly beneficial given that the ACA generally prevents a business with only two employees who are married to each other from obtaining a group health insurance plan. States have some flexibility on this, but if you’re in a state where your only option is an individual market plan, the IRS rule allowing spouses to be considered one covered employee allows the self-employed couple the option to deduct their premiums.
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 were expanded for 2018 to include an HSA-qualified plan design. And while HHS has dropped the standardized plan approach altogether for 2019 and beyond, the agency noted in 2019 rulemaking that they “would like to encourage issuers to offer HDHPs that can be paired with a health savings account (HSA) as a cost-effective option for enrollees.”
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 2018, the contribution limit is $3,450 for people who have individual coverage under an HDHP, and $6,850 for those who have family coverage (two or more people) under an HDHP (note that the family contribution limit had initially been set at $6,900 for 2018, but the IRS reduced it in a March 2018 bulletin, due to changes—prescribed in the Tax Cuts and Jobs Act—to the way the inflation adjustment is calculated).
The contribution is deducted “above the line” on the 1040, which means it’s available to filers regardless of whether they itemize deductions. And there are no income limits in terms of who can contribute to an HSA — anyone who has an HSA-qualified HDHP can contribute. 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.
Republican lawmakers introduced several bills in 2017 aimed at repealing or changing various aspects of the ACA, and most of them included an increased emphasis on HSAs. None of those bills passed, but the GOP did enact their tax reform bill in December 2017, which included repeal of the ACA’s individual mandate penalty starting in 2019 (there is still a penalty for being uninsured in 2018, but there will not be a penalty for people who are uninsured in 2019 and beyond). The tax bill did not, however, make any changes to the rules governing HSAs, although that could come with future legislation.
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 of at least 100 percent of the federal poverty level (FPL) but not more than 400 percent of FPL, as long as the enrollees do not have access to Medicaid or 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 2018, the 2017 poverty level is used, and the upper annual income threshold for subsidy eligibility is $48,240 for a single individual and $115,120 for a family of five (in the continental US; Alaska and Hawaii have higher poverty level guidelines).
The relatively high income limits mean that premium tax credits are widely available: of the 10.3 million people who had effectuated coverage with private health plans through the exchanges as of 2017, about 84 percent qualified for premium tax credits. Nationwide, the average premium subsidy in 2017 was $371 per month. For 2018, the premium subsidies are much larger in most states, due to the way the cost of cost-sharing reductions was added to silver plan premiums, thus driving subsidies much higher than they would otherwise have been. This presented particular bargains for some shoppers who chose bronze or gold plans for 2018.
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.
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 7.5 percent of your adjusted gross. This is the threshold that was in effect through 2012 (and for filers who were 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), but the ACA increased the threshold to 10 percent, meaning that people could only deduct medical expenses that exceeded 10 percent of their income.
However, the GOP tax bill that was enacted in December 2017 contained a provision that temporarily reset the threshold to 7.5 percent, for 2017 and 2018. Starting in 2019, tax filers will only be able to deduct medical expenses that exceed 10 percent of their income. But for the time being, the 7.5 percent threshold applies, making it easier for people to deduct their medical expenses if they itemize their deductions.
Spending 7.5 percent of your income on medical costs 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.
Louise Norris is an individual health insurance broker who has been writing about health insurance and health reform since 2006. She has written dozens of opinions and educational pieces about the Affordable Care Act for healthinsurance.org. Her state health exchange updates are regularly cited by media who cover health reform and by other health insurance experts.