Prior to 2010, self-employed persons who are taxed as a sole proprietorship or partnership could not deduct their health insurance premiums from their business income to reduce their self-employment tax (aka social security tax). For 2010 only self-employed people can deduct their health insurance premiums to reduce their self employment tax.
In this economic climate, any kind of bottom line tax savings is helpful. This is one of the few small business provisions that’s been passed where business owners will actually see lower taxes on Apr. 15, 2011.
The new provision corrects what some call a fundamental unfairness: Self-employed individuals cannot deduct the full cost of health insurance premiums as a business expense on their payroll taxes, as other business entities can do.
Although the new law authorizes the deduction only for 2010 this is a foot in the door for self-employed individuals, who pay both the employer and employee portions of the payroll tax—a self-employment tax totaling 15.3 percent. Employees typically pay half that amount (7.65 percent) and their employers cover the other half as part of their payroll taxes. The new deduction exempts solo business owners from paying self-employment tax on the portion of their income that they spend on health premiums.
In order to take advantage of it, you must buy your own insurance (rather than relying on a spouse’s coverage or being uninsured) and you must pay self-employment tax on business income (rather than declaring a business loss). The deduction phases out above a $106,800 annual income limit.