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Self-employed health insurance deduction 2015

Entrepreneurs need to keep an eye on changing tax code

  • By
  • contributor
  • December 22, 2014

Updated February 25, 2015

The last several years of economic uncertainty and high unemployment have inspired many people to become self employed, and the ACA has made that option easier to pursue.  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 2015, 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 on 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

[Edit: updated February 25, 2015]  For the last few months, there has been considerable confusion with regards to more-than-2% shareholders in an S-corp.  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 the 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.  Until late February 2015, the IRS had not directly addressed the issue of 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).

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 at the time, most accountants – and the IRS attorney I spoke with in early January – 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 are covered by individual (ie, non-group) health insurance.

In late February however, the IRS released Notice 2015-17, and it’s very good news for more-than-2% S-corp shareholders, as well as any other small business that is 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 won’t kick in 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 are exempt from the ACA’s market reforms in 2015, and possibly beyond – further guidance is forthcoming (although if they have employees who are not more-than-2% shareholders, those employees cannot be reimbursed for individual health insurance).
  • 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.  This will be 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).

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 2014, the contribution limits are $3,300 for a single individual and $6,550 for a family.  For 2015, the contribution limits are increasing to $3,350 for an individual and $6,650 for a family.

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.

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 have traditionally had to foot the entire bill for their health insurance.  Employees who get employer-sponsored health insurance typically enjoy a substantial subsidy in the form of employer contribution to the premium, and 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.  For the 2015 open enrollment period and for plans obtained later in 2015 due to qualifying events, the 2014 poverty level is used, and the upper annual income threshold for subsidy eligibility is $46,680 for a single individual and $111,640 for a family of five.

The subsidies can be paid directly to health insurance carriers on a monthly basis to reduce the amount that insureds have to pay for their coverage.  And the relatively high income limits mean that they’re widely available: of the 8 million people who enrolled in private health plans through the exchanges during the 2014 open enrollment period, 85 percent qualified for premium tax credits.  For those enrollees, premiums were an average of 76 percent lower than the retail rates because of the subsidies.

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 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 can still be deducted through the end of 2016.

But starting in 2017, all filers will be 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 – just in case.

Editor’s note:  This post was originally written in September 2013, but was updated in December 2014, and again in February 2015, to reflect changes that apply to 2015.