Tax Season Lesson #5: Reporting Health Insurance Premiums Paid by Partnerships and S Corporations on Behalf of Partners and Shareholders
CPAs are often their own worst enemies, and I say this not with regards to the long hours that stress our heart, the accompanying fast food that softens our midsections, and the prolonged exposure to fluorescent lighting that over time will leave the male portion of our population unable to get their soldiers to salute. Rather, we often sabotage ourselves and make things more difficult than they need to be by failing to search for an adequate authority when confronted with a problematic issue.
Consider the following alternative fact patterns:
Situation 1. A and B each own 50% of AB LLC. During 2011, AB LLC paid health insurance premiums for 2011 coverage on behalf of both A and B under AB LLC’s health plan.
Situation 2. C and D each own 50% of the stock of CD, Inc. an S corporation. C and D are also employees of CD, Inc. During 2011, CD, Inc. paid health insurance premiums for 2011 coverage on behalf of all of its employees, including C and D.
Question: How do AB, LLC, A and B, CD, Inc. and C and D account for the health insurance premiums paid by the partnership and S corporation, respectively?
In the absence of proper guidance, trying to determine the proper treatment of entity-paid health insurance premiums could easily send a CPA on a wild goose chase, leapfrogging from Section 401 to 106 to 1402 to 162(l) without ever finding a definitive answer. Such wayward wondering is responsible for many of the creative — albeit incorrect — tax return presentations of these items I’ve witnessed over the years.
But with a little digging, you’ll find that the IRS has wrapped these seemingly complicated issues up with a nice neat bow, eliminating any of the confusion that might otherwise exist. Revenue Ruling 91-26 covers the two situations posited above, and reaches the following conclusions:
Situation 1: The payment by AB, LLC of health insurance premiums on behalf of partners A and B are treated as guaranteed payments, [i] deductible by the partnership. [ii] A and B must then report the premiums paid on their behalf as guaranteed payment income on their individual tax returns. [iii] A and B can then deduct the premiums on Page 1 of their Form 1040 as self-employed health insurance. [iv]
Alternatively, Revenue Ruling 91-26 provides that AB, LLC may also treat the health insurance premiums paid on behalf of A and B as distributions. In this case, AB, LLC receives no deduction for the payments, but A and B may still deduct the cost of the premiums on Page 1 of their Form 1040 as self-employed health insurance.
Situation 2: Because Section 1372 provides that for purposes of the fringe benefit rules, any person who owns more than 2% of stock in an S corporation is treated as a partner in a partnership, the Ruling reaches the same conclusion as that found in Situation 1: CD, Inc. is entitled to deduct the cost of the health insurance premiums paid on behalf of C and D as part of the compensation paid to C and D. In turn, C and D, like partner A and B above, are required to include the value of the premiums in their respective wages. [v] C and D may then deduct the premiums paid on their behalf on Page 1 of their Form 1040 as self-employed health insurance. [vi]
As opposed to Situation 1, however, CD, Inc. may nottreat the premiums as distributions to C and D.
not be specially allocated to the partners on whose behalf the premiums were paid.
employee any coverage provided by an employer under a health plan, the premiums paid on behalf of a partner is not excludible, because the benefit is treated as a distributive share of partnership income for purposes of the fringe benefit rules, and a partner is treated as self employed to the extent of his distributive share. Note, the guaranteed payment income should be specially allocated to A and B based on their respective share of premiums paid.
