Self-employed health insurance deduction

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.

Prior to 2014, self-employed people 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. And those premium tax credits have been enhanced by the American Rescue Plan, so they’re larger and more widely available than they used to be (those enhancements have been extended through 2025 by the Inflation Reduction Act).

If you’re self-employed and need to purchase your own health coverage, you can do so during the annual open enrollment period. In most states, this window runs from November 1 to January 15, although some states have different deadlines. The open enrollment period applies both on-exchange and off-exchange, but premium tax credits are only available on-exchange. There are also special enrollment periods linked to various qualifying life events, which allow a person to enroll outside of the annual open enrollment window.

In addition to the premium tax credits, there are other ways that the self-employed can use the tax code to save some money when it comes to healthcare. There are several deductions and tax credits that self-employed people can utilize (always consult with a tax advisor before making decisions about your own finances):

The deduction – which you’ll find on Line 17 of Schedule 1 (attached to your Form 1040) – 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 self-employed premium deduction if you were eligible for group insurance from your spouse’s employer (or your own employer, if you have another job in addition to your self-employment). 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/family (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:

• S-corps can continue to reimburse individual market premiums for their more-than-2% shareholders, until if and when the IRS releases further guidance on this issue (under the terms of Notice 2015-17, however, if an S-corp has employees who are not more-than-2% shareholders, those employees cannot be reimbursed for individual health insurance). As of early 2023, 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. As of 2022, that IRS page had noted that the IRS was still “contemplating publication of additional guidance on the application of the market reforms to a 2-percent shareholder-employee healthcare arrangement.” But that language was no longer present on the page as of 2023.
• 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 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 if they own an S-Corp.

In the years since 2015, there have been some rule changes regarding employers reimbursing employees for individual market premiums. When the ACA was first implemented, the federal government took a hard-line approach (as noted above) and prohibited any form of employer reimbursements for individual market insurance premiums. But the 21st Century Cures Act brought QSEHRAs into being, allowing small employers to reimburse employees for individual health insurance premiums starting in 2017. And then the Trump administration further expanded the rules, allowing ICHRAs to exist as of 2020.

But the rules described above for more-than-2% shareholders of an S-corp are even easier. The S-corp isn’t required to establish a QSEHRA or ICHRA. It can simply reimburse the shareholder for some or all of the cost of the individual market health plan, and then include the reimbursement amount in the shareholder’s W2 income (so if the shareholder earns a W2 wage of $50,000 and also receives $5,000 in health insurance premium reimbursements, their income reported in W2 Box 1 would be $55,000; note that the health insurance reimbursement amount is not added to Box 3 or Box 5, since the reimbursement is not subject to Medicare, Social Security, or unemployment taxes).

The shareholder can then deduct that amount using the self-employed health insurance deduction when they file their 1040 (so in the example above, they’d receive $55,000 in compensation from the S-corp, but they would only pay federal income tax on $50,000 of it). The self-employed health insurance deduction is taken “above the line,” which means it’s deducted before AGI is calculated, resulting in a lower AGI (in contrast, itemized deductions are taken after AGI is calculated), and thus also a lower ACA-specific MAGI.

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 been the case, and HSA-qualified plans are still a popular choice in the individual market.

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. For 2023, the HSA contribution limits are $3,850 for people who have individual coverage under an HDHP, and $7,750 for those who have family coverage (two or more people) under an HDHP. In 2022, those limits were $3,650 and $7,300, respectively. And contributions can be made up until the tax-filing deadline, so the deadline for making 2022 HSA contributions is April 18, 2023 (the deadline is normally April 15, but holidays and weekends sometimes result in a slightly later deadline).

As is the case with the self-employed health insurance deduction, HSA contributions are deducted “above the line” on Form 1040, which means the deduction is 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 (and meets the rest of the eligibility requirements set by the IRS) can contribute to an HSA with pre-tax money.

Although the money in an HSA 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, assuming you’re using the money for something other than qualified medical expenses.

Even before the American Rescue Plan eliminated the subsidy cliff and made subsidies larger, most exchange enrollees received substantial subsidies that offset the majority of their premiums. As of early 2021 (ie, pre-ARP), 86% of exchange enrollees qualified for premium tax credits (subsidies) that averaged $486/month (versus average full-price health insurance premiums of about $575 per month; premium subsidies covered most of the premium for most enrollees, and that’s even more true now that the ARP has been implemented). For 2022, the average subsidy amount grew to $505/month, and 89% of enrollees were receiving a subsidy.

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.

And you can only deduct expenses in excess of 7.5% of your adjusted gross. This is the threshold that was in effect through 2012, but the ACA increased the threshold to 10%, meaning that people could only deduct medical expenses that exceeded 10% of their income. However, the Tax Cuts and Jobs Act that was enacted in December 2017 contained a provision that temporarily reset the threshold to 7.5%, for 2017 and 2018. And Section 103 of the Further Consolidated Appropriations Act, 2020, enacted in December 2019, kept that lower threshold in place for tax years 2019 and 2020. Then the Consolidated Appropriations Act, 2021 (Title I, Section 101) permanently reset the threshold at 7.5%, making it easier for tax filers to continue to qualify for this deduction.

Spending 7.5% of your income on medical costs can be a hard target to hit unless you’re dealing with a significant illness or injury (and keep in mind that you can only deduct the portion of your expenses that exceed that threshold). Still, it’s one more good reason to keep track of your medical bills and health insurance premiums – just in case.

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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.