Back to Employer Provided Health Insurance

Stockholder-Employees, Self-Employed Individuals

  • 346. How are accident or health benefits taxed when provided by a closely held C corporation only to its stockholder-employees?

    • To provide tax-free coverage and benefits, an employer’s accident or health plan must be for employees.[1] The same is true with respect to amounts received under a state’s sickness and disability fund under IRC Section 105(e)(2).

      The IRS can challenge tax benefits claimed under a plan that covers only stockholder-employees on the ground that the plan is not for employees. The underlying problem is in establishing that the stockholder-employees are covered as employees rather than as stockholders. If this cannot be established, then premiums or benefits are likely to be treated as constructive dividends. The premiums will be nondeductible by the corporation and the premium costs will have to be reported by the shareholder as dividend income to the extent of the corporation’s earnings and profits.[2]

      Courts have taken the position that the tax benefits of employer-provided health insurance are available in a plan that covers only stockholder-employees if the plan covers a class of employees that can be segregated rationally from other employees, if any, on a criterion other than their being stockholders.[3]

      The Bogene, Smith, Seidel, and Epstein cases were decided in favor of taxpayers; the plans in all of them covered only active and compensated officers of the corporation who also were stockholders.

      In Smith and Seidel, the officer-shareholders also were the only employees, but in Bogene and Epstein there were other employees who were not shareholders and who were not covered.

      The plan in American Foundry covered only two of five active officers of a family corporation and was held not to be a plan for employees.

      The plan in Sturgill covered four officer-stockholders of a family corporation but two of the four were not active or compensated as officer-employees and the plan was held not to be one for employees.

      The plan in Leidy covered only the president, who was the sole stockholder, and the vice president, who was no longer active in the company.

      In American Foundry and in Sturgill, courts allowed the corporations to deduct reimbursement payments to the active officers as reasonable compensation, even though the payments were not excludable by shareholder-employees under IRC Section 105.

      For situations involving S corporations, see Q 348.


      1.    IRC § 105(e).

      2.    Levine v. Commissioner, 50 TC 422 (1968); Larkin v. Commissioner 394 F.2d 494 (1st Cir. 1968).

      3.  American Foundrgy v. Comm., 536 F.2d 289, 76-1 USTC ¶ 9401 (9th Cir. 1976); Oleander Co., Inc. v. U.S., 50 AFTR 2d 82-5170, 82-1 USTC ¶ 9395 (E.D.N.C. 1981); Bogene, Inc. v. Comm., TC Memo 1968-147; Smith v. Comm., TC Memo 1970-243; Seidel v. Comm., TC Memo 1971-238; Epstein v. Comm., TC Memo 1972-53; Charlie Sturgill Motor Co. v. Comm., TC Memo 1973-281; Giberson v. Comm., TC Memo 1982-338; Est. of Leidy, 34 TCM 1476 (1975); Wigutow v. Comm., TC Memo 1983-620.

  • 347. How is health insurance coverage taxed for partners and sole proprietors?

    • Partners and sole proprietors are self-employed individuals, not employees, and the rules for personal health insurance apply (Q 342, Q 343). Partners and sole proprietors can deduct 100 percent of amounts paid during a taxable year for insurance that provides medical care for the individual, his or her spouse, and dependents during the tax year. The insurance can also cover a child who was under age 27 at the end of the tax year, even if the child did not qualify as the taxpayer’s dependent. A child includes a taxpayer’s son, daughter, stepchild, adopted child, or foster child. A foster child is any child placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction.

      Certain premiums paid for long-term care insurance are also eligible for this deduction (Q 488).[1]

      The deduction is not available to a partner or sole proprietor for any calendar month in which he or she is eligible to participate in any subsidized health plan maintained by any employer of the self-employed individual or his or her spouse. This rule is applied separately to plans that include coverage for qualified long- term care services or are qualified long-term care insurance contracts (Q 477) and plans that do not include that coverage and are not those kinds of contracts.[2]

      The deduction is allowable in calculating adjusted gross income and is limited to the self-employed individual’s earned income for the tax year that is derived from the trade or business with respect to which the plan providing medical care coverage is established. Earned income is, in general, net earnings from self-employment with respect to a trade or business in which the personal services of the taxpayer are a material income producing factor. Other rules govern contributions made to a qualified retirement plan (Q 3928).

      Any amounts paid for this kind of insurance may not be taken into account in computing (1) the amount of a medical expense deduction under IRC Section 213, and (2) net-earnings from self-employment for the purpose of determining the tax on self-employment income.[3]

      If a partnership pays accident and health insurance premiums for services rendered by partners in their capacity as partners and without regard to partnership income, premium payments are considered to be guaranteed payments under IRC Section 707(c). Thus, the premiums are deductible by the partnership under IRC Section 162, subject to IRC Section 263, and includable in partners’ income under IRC Section 61. A partner may not exclude premium payments from income under IRC Section 106 but may deduct payments to the extent allowable under IRC Section 162(l), as discussed above.[4] For partners, a policy can be either in the name of the partnership or in the name of the partner. The partner can either pay the premiums him or herself, or the partnership can pay them and report the premium amounts on Schedule K-1 (Form 1065) as guaranteed payments to be included in the partner’s gross income. However, if the policy is in the partner’s name and the partner pays the premiums him or herself, the partnership must reimburse the partner and report the premium amounts on Schedule K-1 (Form 1065) as guaranteed payments to be included in the partner’s gross income. Otherwise, the insurance plan will not be considered to be established under the business.

      Reasoning that consumer medical cards that provide discounts on certain medical services and items are not an insurance product, the IRS has concluded that the cost of these cards purchased for partners is not deductible by partners under either IRC Section 162(l) or IRC Section 213.[5] (See Q 8789.)

      Regarding the income tax consequences of a self-funded medical reimbursement plan set up by a partnership, the IRS has concluded that payments from a plan made to partners and their dependents are excludable from partners’ income and premiums paid by partners for coverage under a self-funded plan are deductible, subject to the limits of IRC Section 162(l).[6]

      There is no limit on the amount of benefits a partner or sole proprietor can receive tax-free.[7]

      For tax treatment of business overhead disability insurance, see Q 378.

      The IRS has ruled that coverage purchased by a sole proprietor or partnership for non-owner-employees, including an owner’s spouse, is subject to the same rules that apply in any other employer-employee situation.[8]

      The IRS has issued settlement guidelines that address whether a self-employed individual (“employer-spouse”) may hire his or her spouse as an employee (“employee-spouse”) and provide family health benefits to the employee-spouse, who then elects family coverage including the employer-spouse. Essentially, the IRS position is that if an employee-spouse is a bona fide employee, the employer-spouse may deduct the cost of the coverage and the value of the coverage also is excludable from the employee-spouse’s gross income.

      IRS agents are to use the settlement guidelines to closely scrutinize whether an employee-spouse qualifies as a bona fide employee; merely calling a spouse an employee is insufficient. Part-time employment does not negate employee status, but nominal or insignificant services that have no economic substance or independent significance will be challenged.[9]


      1.    IRC §§ 162(l), 213(d)(1).

      2.    IRC § 162(l).

      3.    IRC § 162(l).

      4.    Rev. Rul. 91-26, 1991-1 CB 184.

      5.    Let. Rul. 9814023.

      6.    Let. Rul. 200007025.

      7.    Rev. Rul. 56-326, 1956-2 CB 100; Rev. Rul. 58-90, 1958-1 CB 88.

      8.    Rev. Rul. 71-588, 1971-2 CB 91; TAM 9409006.

      9.    IRS Settlement Guidelines, 2001 TNT 222-25 (Nov. 16, 2001); see also Poyda v. Comm., TC Summary Opinion 2001-91.

  • 348. How is health insurance coverage taxed for S corporation shareholders?

    • The IRS issued guidance late in 2014 indicating that accident and health insurance premiums paid to insure a greater than 2-percent S corporation shareholder are treated as wages by the shareholder and are deductible by the S corporation. However, these benefits are not subject to FICA, FUTA or Social Security taxes. The S corporation shareholder is entitled to an above-the-line deduction for amounts paid throughout the year for medical premiums, but only if neither the shareholder nor his or her spouse are otherwise eligible to participate in any subsidized health care plan offered by another employer. The IRS released a CCM clarifying that this remains the case even if the 2-percent shareholder-employee is treated as a 2-percent shareholder via the family attribution rules.1


      Planning Point: The IRS has released a set of frequently asked questions based upon the regulations governing the new Section 199A deduction for pass-through entities, such as S corporations. The FAQ provides that health insurance premiums paid by the S corporation for a greater-than-2-percent shareholder reduce qualified business income (QBI) at the entity level (by reducing the ordinary income used to calculate QBI). Similarly, when a self-employed individual takes a deduction for health insurance attributable to the trade or business, this will be a deduction in determining QBI and can reduce QBI at the entity and individual levels.2


      Unlike in traditional employment situations, the IRS has also noted that if the S corporation shareholder is the sole shareholder, he or she may purchase the insurance in his or her own name, but allow the S corporation to either directly pay for the premiums or reimburse the sole shareholder for those premiums, and still be entitled to the above-the-line deduction for premiums paid. In either case, the premium payment must be reported on the shareholder’s W-2 as wages.3


      Planning Point: Employers now have the option of using a QSEHRA or ICHRA to reimburse employees for individual health insurance premiums without incurring potentially substantial penalties under the ACA.


      With respect to coverage purchased by an S corporation for employees not owning any stock and for shareholder-employees owning 2 percent or less of the outstanding stock or voting power, the same rules apply as in any other employer-employee situation (Q 8789).


      1.    CCM 201912001.

      2.   FAQ is available at: https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-provision-11011-section-199a-qualified-business-income-deduction-faqs (last accessed Oct. 1, 2023).

      3.  See IRS Guidance, S Corporation Compensation and Medical Insurance Issues, accessible at: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues (last accessed Oct. 1, 2023).