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How to Claim a Tax Deduction for Health Insurance When You are Self-employed 
 
by kmhagen June 23, 2005

If you are self-employed you may be able to find some tax relief to help you maintain your health insurance coverage. For U.S. federal income tax purposes, you can deduct up to 100% of the amount you pay for medical and qualified long-term care insurance for yourself, your spouse, and dependents.

Who Qualifies?

You are eligible for this tax deduction if any of the following apply to you:

  • You were self-employed and had a net profit for the year, as reported on Schedule C, C-EZ, or F.
  • You were a general partner with net earnings from self-employment as reported on Schedule K-1 (Form 1065).
  • You were a limited partner receiving guaranteed payments.
  • You received wages from an S corporation in which you were a more than 2% shareholder.

You may qualify for the deduction whether you paid the premiums yourself or your partnership or S corporation paid them for you and you included the premiums in your gross income.

Establish the Plan Under Your Trade or Business

In order to be deductible, the health insurance plan must be established under your trade or business.  The plan can still cover you, your spouse and dependents, but it must be set up under your business name.  You should take this into consideration when you first take out health insurance coverage, or if you already have a personal health insurance policy, you may want to see how you could change it so that it is set up under your business.

If You Have Medical Insurance Coverage Through an Employer

If you are self-employed part-time and also work as an employee, you may have medical insurance coverage through your employer.  Or you may be covered by medical insurance provided by your spouse’s employer.  In this case, you cannot take the deduction for self-employed health insurance for any month in which you were eligible to participate in a subsidized health care plan maintained by your or your spouse’s employer.  Reference here is made to months of coverage, so you still may be able to claim the self-employed health insurance deduction for the portion of the year in which you are not covered by an employer-subsidized plan.  Health insurance benefits paid for you by your employer may be shown in box 14 of your W-2 Form. 

How to Claim the Deduction

Adjustment to Income

Medical insurance premiums can normally be claimed as an itemized deduction.  Itemized medical expense deductions are subject to a limitation of 7.5% of adjusted gross income.  But for the self-employed, there is a special deduction that can be taken as an adjustment to income for adjusted gross income.  So it is not subject to a limitation, and directly reduces the amount of your income subject to tax.

Worksheet

There is a worksheet in the instructions for Form 1040 to figure the amount you can deduct.  This worksheet is basically for separating regular health insurance premiums from long-term care premiums, subject to the limitations per person mentioned below, and then determining the maximum amount you can deduct based on your net earnings from the business under which the health insurance plan is established.  If you have more than one health insurance plan established under different businesses, you need to complete a separate worksheet for each one to determine the amount you can deduct for that particular plan.

Exception

If any of the following apply, you will need to see the instructions in IRS Publication 535 – Business Expenses, instead of the worksheet in the instructions for Form 1040:

  • You had more than one source of income subject to self-employment tax.
  • You file Form 2555 or 2555-EZ (exclusion of foreign-source earned income).
  • You are using amounts paid for qualified long-term care insurance to figure the deduction.

Itemized Deduction

If you cannot claim a deduction for 100% of the cost of your health insurance coverage as an adjustment to income (because it exceeds your earned income), you can include any remaining premiums along with all your other deductible medical care expenses as an itemized deduction.  The amount you can claim as an itemized deduction would be subject to the limit of 7.5% of adjusted gross income.

Long-term Care Insurance

Your deduction for self-employed health insurance can include premiums for qualified long-term care insurance for you, your spouse, and your dependents.  But there are limits for the long-term care portion of the insurance that are defined based on each person’s age.  You can claim the smaller of the actual amount you spent for each person’s coverage or the amounts established by the IRS.  These limitation amounts are progressive, increasing based on the person’s age.  You can find these amounts in IRS Publication 535 – Business Expenses, in the chapter on insurance expense deductions.

In general terms, in order to qualify, the long-term care insurance contract must meet the following conditions:

  • It must be guaranteed renewable.
  • It must provide that any refunds or dividends under the contract can only be used to reduce future premiums or increase future benefits.
  • It must not provide for a cash surrender value.
  • It must not pay or reimburse expenses that would normally be reimbursed by Medicare, except where Medicare is a secondary payer.

In order for the long-term care services to qualify, they must be for the diagnosis, prevention, or treatment of illnesses or medical conditions, or for the maintenance or personal care services of a chronically ill person, and must be prescribed by a licensed health care practitioner.  A chronically ill individual for these purposes is someone who for at least 90 days, due to a loss of functional capacity, has been unable to perform daily living activities without substantial assistance from another person.

Effect on Self-employment Tax

The self-employment tax calculated and reported on Schedule SE is for social security and Medicare purposes.  The special deduction for self-employed health insurance is a separate matter, that involves medical insurance you take out yourself, by establishing a health coverage plan under the business.

In this regard, the self-employed health insurance deduction should not be subtracted from your net earnings for purposes of determining the self-employment tax reported on Schedule SE.


 




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