In Chief Counsel Advice (CCA), the IRS has provided guidance on the requirements for a sole proprietor, partner, or 2% shareholder of an S corporation to deduct Medicare premiums as medical care insurance. Further, the CCA concludes that all Medicare parts, and not just the supplemental medical insurance of Medicare Part B, are insurance constituting medical care.
A self-employed individual—i.e., a sole proprietor, partner, or more-than-2%-shareholder of an S corporation—can deduct as a business expense the amount paid during the tax year for medical insurance on himself, his spouse and his dependents, or a child. However, no deduction is allowed for a self-employed individual’s health insurance costs to the extent that the deduction exceeds his earned income derived from the trade or business with respect to which the plan providing the medical care coverage was established.
The deduction isn’t available to any taxpayer for any calendar month for which the taxpayer is eligible to participate in any subsidized health plan maintained by any employer of the taxpayer or of the spouse of the taxpayer.
For purposes of applying the income tax provisions relating to employee fringe benefits, an S corporation is treated as a partnership, and any 2% shareholder of an S corporation is treated as a partner of the partnership. A 2% shareholder-employee in an S corporation is eligible for the deduction if the plan providing the medical care coverage for the 2% shareholder-employee is established by the S corporation.
A 2% shareholder of an S corporation, who is otherwise eligible to deduct medical insurance, may do so only if the plan providing medical care coverage for that shareholder is established by the S corporation—that is, (1) the S corporation makes the premium payments for the accident and health insurance policy covering the 2% shareholder (and his spouse, dependents, or child under age 27, if applicable) in the current tax year; or (2) the 2% shareholder makes the premium payments and furnishes proof of premium payment to the S corporation and then the S corporation reimburses the 2% shareholder for the premium payments in the current tax year.
If the accident and health insurance premiums aren’t paid or reimbursed by the S corporation and included in the 2% shareholder’s gross income, a plan providing medical care coverage for the 2% shareholder isn’t established by the S corporation and the 2% shareholder in an S corporation isn’t allowed the deduction for medical insurance. In order for the 2% shareholder to deduct accident and health insurance premiums, the S corporation must report the accident and health insurance premiums paid or reimbursed as wages on the 2% shareholder’s Form W-2, Wage and Tax Statement, in that same year. Moreover, the shareholder must report the premium payments or reimbursements from the S corporation as gross income on his Form 1040, U.S. Individual Income Tax Return.
In the CCA, IRS preliminarily concludes that all Medicare Parts (i.e., in addition to Medicare Part B) are insurance that constitutes medical care under Code Sec. 162(l). IRS reasons that all Medicare premiums are similar to other health insurance premiums and can be used to compute the deduction. This conclusion extends to Medicare premiums for coverage of a self-employed individual’s spouse, dependent, or child (who as of the end of the tax year hasn’t attained age 27).
Further, while the instructions to Form 1040 for 2009 and prior years omit any mention of Medicare premiums, the instructions to Form 1040 (2010), p. 28, indicate that Medicare premiums can be used to compute the deduction under Code Sec. 162(l). The CCA notes that self-employed individuals who failed to deduct Medicare premiums in prior years may file an amended return to claim a refund for open tax years.
The provision in the 2010 Instructions to Form 1040—which provided that Medicare Part B premiums could be deducted—was a reversal of IRS’s long-held position that Medicare premiums weren’t deductible under Code Sec. 162(l). The IRS had previously argued that Medicare Part B wasn’t a health insurance plan established under a trade or business, as required under Code Sec. 162(l), because it was a federal program available only to those who qualify under the statute.
Moreover, the 2010 Instructions confined itself only to the deductibility of Medicare Part B premiums. In Chief Counsel Advice, the IRS has now expanded its guidance on when Medicare premiums are deductible under Code Sec. 162(l) to include all Medicare premiums.
For the premiums to be deductible under Code Sec. 162(l), a partner in a partnership may pay the premiums directly and be reimbursed by the partnership, or the premiums may be paid by the partnership. In either case, the premiums must be reported to the partner as guaranteed payments, and he must report the guaranteed payments as gross income on his Form 1040.
Similarly, a 2% shareholder-employee in an S corporation may pay the premiums directly and be reimbursed by the S corporation, or the premiums may be paid by the S corporation. In either case, the premiums must be reported to the 2% shareholder-employee as wages on Form W-2, and he must report this amount as gross income on his Form 1040.
A sole proprietor must pay the Medicare premiums directly.
In Chief Counsel Advice 200524001, IRS said that health insurance that is purchased in a self-employed individual’s name, rather than in his business name, can qualify for the deduction. A sole proprietor who purchases health insurance in his individual name is treated as having established a plan providing medical care coverage with respect to his trade or business, and therefore qualifies for the deduction.
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