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IRS: ABOVE-THE-LINE DEDUCTION FOR S CORP HEALTH INSURANCE ONLY WORKS FOR COMPANY-OWNED POLICIES

May 31, 2006

The income tax law has always had strange treatment for health-insurance costs for self-employed taxpayers, partners, and S corporation owner-employees. For many years these folks could deduct none of their health insurance, except as an itemized deduction. The 7.5% of AGI floor on itemized health deductions made this worthless.

Over the years, an "above-the line" deduction was phased in erratically, starting at 25% of health insurance expense. In recent years these taxpayers could deduct all of their health insurance "above the line," without having to clear the 7.5% of AGI hurdle.

The IRS has decided to make it just a little harder for S corporation owners to qualify for this deduction. According to an announcement yesterday, S corporation shareholders will be able to take their health insurance costs "above the line" only when the S corporation has purchased the health insurance.

This means S corporation shareholder-employees need to make sure that they have their corporations purchase their health insurance and include it in their W-2 income; otherwise the IRS will challenge the deduction. Partners and sole proprieters are unaffected by the announcement.

(Hat tip: Taxable Talk)

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