When your S corporation covers or reimburses your more-than-2-percent-shareholder-employee health insurance expenses, it classifies the payments as box 1 W-2 wages but not box 3 or box 5 wages.
When calculating the amount eligible for the Form 1040 self-employed health insurance deduction, you must use your Medicare wages (listed in box 5 of Form W-2) as your “earned income” rather than the amount reported in box 1.
Here are two examples that show you the impact of this rule:
Ted’s S corporation pays him $0 in cash wages and reimburses him $18,000 for health insurance. His W-2 shows $18,000 as box 1 wages and $0 as box 3 and box 5 wages. Although Ted has $18,000 in taxable wage income from the corporation’s reimbursement of his health insurance, his Form 1040 self-employed health insurance deduction is $0 due to his lack of Medicare wages.
Janet’s corporation pays her $107,000 in cash wages and reimburses her $22,000 for health insurance. Janet’s W-2 from her S corporation shows box 1 wages of $129,000, box 3 wages of $107,000, and box 5 wages of $107,000. The IRS allows her Form 1040 self-employed health insurance deduction of $22,000 because her Medicare wages exceed the insurance cost.
To avoid unfavorable tax outcomes, ensure that your S corporation reports Medicare wages (box 5) equal to or greater than the health insurance costs paid or reimbursed.