I have gotten several questions over the last couple months about medical expenses and the best way to deduct them as a freelancer. If you are one of those that asked, you probably got a non-committal answer – which is probably as frustrating to receive as it is to give! The reason is that many of the things surrounding health insurance (and also health expenses, which can be treated differently) have been up in the air for a long time.
A summary of why:
We deducted medical expenses under the idea that the company had a “health reimbursement arrangement” (HRA) – that your employee had a non-taxable benefit plan that they could reimburse for expenses.
There was also guidance that allowed you to deduct medical insurance. For S-corp shareholders, this is always a little tricky, especially if you don’t run “official” payroll out of the company, but is definitely possible. The important point here is that an HRA was still considered a “health plan”.
Then the Affordable Care Act came along. It did a lot of things – but one of them was to say that “all health plans must cover these certain things”. Now, what they MEANT was that if your employer provided your health insurance, the insurance had to cover those basic needs. But what they *said* was “health plan”. And since an HRA is technically a “health plan”, it fell under those rules. But – and here is the rub – Since an HRA is a reimbursement arrangement, the employer doesn’t actually pick the benefits. So they are liable for making sure their benefit covers certain minimums, but have no ability to actually make sure the employees get those things.
So we spent about two years with some people canceling their HRAs, others pretending the new law doesn’t exist and the IRS basically scratching their head going, “We don’t really know what to do with this”.
Enter the Qualified Small Employer Health Reimbursement Arrangement. This was included in a new bill that Obama signed mid-December. Basically, it says “yeah, it’s cool – we didn’t mean to screw up your HRAs. Our bad.” It ALSO clarified some issues for us. So, the verdict on how to deduct medical using the new QSEHRA plan is:
- An S-Corp can pay for health expenses (both insurance and copays/expenses) of its employees. – This is a full deduction for the company
- IF the employee is also an owner with more than 2% of the shares (which is basically all of you) then both these amounts get added to your W-2, but is exempt from FICA (read Self-Employment) Tax
- On your personal return, you can deduct the health insurance that showed up on your W-2.
The sole owner of an S-Corp can pay for health insurance tax free and for health expenses FICA tax free.
If you have other employees, like, say your spouse, who aren’t owners, they can deduct health insurance and health expenses income & FICA tax free.
Remember that the idea behind the S-Corp is to pay less FICA tax overall, but we still have to pay ourselves compensation. But these health benefits (which aren’t subject to FICA tax) are considered compensation – so we have less we have to pay out.
I’ll have more information on this – and how to practically do this – down the road as I find good vendors to make it function. But in the meantime – hope this helps!