Big Break for Self-Employed Health Insurance Deduction

• Posted on July 6, 2010
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Long Island CPA Firm Offering Tax and Financial Advice

Background - A self-employed individual (or a partner or a more-than-2%-shareholder of an S corporation) can deduct as an above-the-line expense 100% of the amount paid during the tax year for medical insurance on behalf of himself, his spouse and his dependents subject to the following requirements (Code Sec. 162(l)(1)(B)):

• The deduction cannot exceed the individual’s net earnings from self-employment derived from the trade or business for which the plan providing the coverage is established.
  
  
• For a more-than-2% S corporation shareholder, that shareholder's wages from the S corporation are treated as his earned income.
  
  
• No individual who is eligible to participate in any subsidized health plan maintained by any employer of the individual or of the individual's spouse is entitled to the deduction.  This test for eligibility is made for each calendar month and applied separately to long-term care insurance.

New Benefit - As part of the new health care reform law (Notice 2010-38), this deduction, as of March 30, 2010, also applies to a self-employed individual’s child under the age of 27 as of the end of the year.  The definition of “child” for this purpose includes the individual’s:

• child,
• stepchild,
• legally-adopted individual, 
• an individual lawfully placed with the employee for legal adoption, and 
• an eligible foster child.   

Previously, the child would have had to qualify as a dependent.  No other requirements apply so long as the individual meets the definition of a child and has not reached age 27 by the last day of the year.  Even a married child is included by this definition!  (But the married child’s spouse and/or children are not covered.) A child attains age 27 on the 27th anniversary of the date the child was born (for example, a child born on April 10, 1983 attained age 27 on April 10, 2010).

If the self-employed individual utilizes a group policy provided by an association, be aware that although group policies offered by insurers are also required to cover older children, they are only required for children under the age of 26.  Also, that law change only becomes effective for plan years beginning on or after September 23, 2010.