Deducting insurance from an S corporation

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Dear Tax Talk,
Your columns are great. They saved me a bundle confirming a question I believed to be true (once) and could not verify anywhere else.

I have a “doing business as,” a d/b/a, that pays for my health insurance and long-term care insurance, which I know is not deductible on Schedule C and is only deductible after the self-employment tax.

The health insurance deduction falls on the front of form 1040 if, only if, there was a profit on Schedule C and there was a profit large enough to cover it all in 2008. The question: Would the health insurance and long-term care insurance be deductible before the self-employment tax with an LLC or S Corp.?

The real problem is that I am collecting Social Security as a result of a deceased spouse.  The d/b/a netted more than $1,130 for eight months in 2008. It looks like I owe 100 percent of the Social Security check for any month over $1,130.

If I had been an S Corp or LLC, would the health insurance and long-term care insurance have been deductible before the net income was figured? I would not owe back as many months of Social Security. The insurance deduction would bring four months under $1,130.
— Charlene

Dear Charlene,
It certainly helps to flatter me when I choose the questions I’ll answer for this week’s columns. I’m glad I was able to help you before and I’m also glad that people take advantage of the archives that are chock full of years of advice.

I’ve said it before; if you’re in business, providing goods or services as distinguished from rental activities, the only form of entity that makes sense is an S corporation. A d/b/a and a single member LLC are the same thing as a sole proprietorship, which is reported on Schedule C.

A multimember LLC is the same as a Schedule C, as both produce a self-employment tax on nondeductible or certain separately deductible items, such as health insurance, nondeductible life insurance premiums, charity, luxury and personal portion of automobiles, reinvestment in plant and equipment, inventory or receivables, etc.

In an S corporation, because these funds are not available to be paid out to the shareholder as salary, the S corporation does not pay employment taxes on these items. Although the S corporation may earn more than $1,130 a month, all of that is not available to be paid to the shareholder as wages.

For example, the S corporation may accumulate funds in its bank account for future needs, it may need to buy inventory or it may need to float costs for a project that it won’t be paid for until later. All these impact the amount that the S corporation can pay as salary, whereas in an LLC or d/b/a, it does not change the amount subject to the self-employment. If you’re unable to receive the amount as salary then you will not be docked by Social Security for exceeding the $1,130 monthly limit.

While the IRS requires that an S corporation include health insurance in gross wages, subject to federal-income-tax-withholding box 1 of form W-2, the insurance is exempt from Social Security and Medicare taxes (boxes 3 and 5).

While I am not an expert on Social Security, wages for the purpose of the earnings limitation does not include employer provided insurance. In any event, with other limitations, the wages that the company is able to pay may be less than the earnings limit, so that this may not be an issue.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.