Medical insurance supports a healthy work-life balance for employees, increasing productivity, boosting employee retention, and improving business performance. But medical insurance is expensive, so can small businesses deduct health insurance? That’s the question owners need to know to avoid choosing between employee performance and controlling costs.
What’s the answer? Yes, a small business can deduct health insurance costs—on one condition.
Business owners will not qualify for the right deductions and credits if their business’s legal entity structure falls outside the IRS’s “Small Business and Self-Employed” category. So check your legal and tax structure this year.
Fighting the rising cost of healthcare
According to a survey from best practices in healthcare, a health insurance plan’s annual cost per employee may be more than $3,300.
Another survey found that HMO plans can cost upwards of $16,253 to cover a family, even if the family shoulders just 75% of the premium.
Making healthcare affordable for employees is imperative for business owners. It’s expensive, but you need talent that feels supported and appreciated.
Let’s explore some opportunities to build strong teams and save on healthcare costs.
What types of healthcare costs are tax deductible?
Tax deductible costs include monthly premiums, contributions to an HSA, and tax-advantaged dollars.
Deduct Your Employer-Share of Monthly Premiums
A business owner that enrolls in group coverage will most likely pay at least 50% of the premiums, while employees will pay the remaining 50%. Typical contributions are 82% for single coverage and 70% for family premiums.
Here’s another upside: employees often take healthcare insurance premiums out of their paychecks. Because this happens on a pre-tax basis, the employee and the business can pay less FICA taxes for the same insurance premium.
Offer Coverage Through Health Savings Accounts (HSAs)
Offering employees a health savings account (HSA) expands options for employees and provides tax deductions: some large, some negligible.
So, what is an HSA?
A company HSA is a kind of “checking account” employees use for medical and health-related purchases. Contributions to the HSA are pre-tax, which means you will also save FICA taxes on that amount.
Prescription drugs, copays, hospital bills, dental, and vision-related expenses are all HSA covered. Recently, the CARES Act added some over-the-counter items to this list, such as allergy medication and aspirin. The IRS offers a complete list in Publication 502.
How much can I deduct?
That depends. Sometimes, contribution limits exceed the maximum tax deduction available for HSAs; this is more typical in larger businesses. Other limiting factors include the subscriber’s age and the type of health plan they carry.
Be sure to ask an experienced CPA if your business qualifies.
Fund Health Reimbursement Accounts (HRAs) with Tax-Advantaged Dollars
If your business cannot afford to sponsor employee premiums, even partially, you can still take advantage of tax-advantaged dollars by helping employees buy their own coverage.
Federal law allows businesses to fund special health reimbursement accounts for employees to buy individual or family plans.
Take the Qualified Small Employer Health Reimbursement Arrangement (QSEHRA). Available to businesses with less than 50 employees, this arrangement creates a monthly allowance for employees to pay or receive reimbursements for healthcare expenses.
Healthcare Tax Deductions vs. Healthcare Tax Credits
Healthcare insurance costs and earlier contributions I mentioned are undoubtedly deductible as business expenses, while applicable tax credits reduce the tax liability resulting from your Form 1040.
Remember: Tax deductions reduce your gross profit, which reduces your taxes owed. By contrast, tax credits are applied dollar for dollar against your tax bill, like subtracting what you owe after the fact.
Healthcare Tax Credits For Small Businesses
The Small Business Healthcare Tax Credit, a part of the Affordable Care Act (ACA), contains additional requirements businesses must satisfy to claim (or qualify for) the small business healthcare credit.
Here are the requirements. Your business must:
- Employ fewer than 25 full-time employees.
- Pay an average annual salary no greater than $56,000.
- Supply healthcare plans from the Small Business Health Options Program (SHOP) Marketplace.
- Cover at least 50% of employee premiums.
Note: Part-time employees working less than 30 hours each week are not required to be provided with health coverage.
So, will this tax credit help a business with more than 25 full-time employees? Not on the surface. But it’s easy to qualify if you keep the bulk of your employees working fewer than 30 hours per week.
Now, is that sustainable? Maybe not. But there’s no denying that how you run your business can and will affect your tax savings for better or worse.
How Much is the Small Business Healthcare Tax Credit Worth?
The value of this tax credit is determined according to a sliding scale that tracks the size of your business.
The maximum credit is 50% of the portion of premiums paid by the business or 35% for a tax-exempt corporation like a nonprofit.
If a business leverages this tax credit, only the excess amount paid for healthcare insurance over the credit amount qualifies as a business expense deduction. Companies may claim the small business healthcare tax credit for two consecutive years.
Can small businesses deduct health insurance costs for its owners, managers, or members?
Let’s start with sole proprietorships. Yes, a sole proprietor can write off 100% of their health insurance expenses, plus expenses incurred by their spouse and any dependents under the age of 27.
Sole proprietors can also leverage an HSA to reduce their tax burden, so long as they have a qualified high-deductible health plan (HDHP).
S-Corps cannot write off owners’ health insurance payments (But LLCs and partnerships can)
Deducting health insurance costs is one perk members of S-Corps miss.
In S-Corps, healthcare premiums paid by non-owner employees are 100% deductible. That leaves owners with more than a 2% share to declare company-paid health insurance costs as income, which means they won’t be able to avoid taxes on those costs.
Of course, it’s nice to have the other benefits of S-corp status, especially avoiding FICA taxes.
Consult an experienced accountant to weigh the pros and cons of different business structures in regard to tax and accounting.
Yes, health insurance costs are tax deductible for businesses
Ask yourself: Why would the IRS provide a deduction to businesses that provide health insurance for employees? It’s easy. The IRS wants employees to have health insurance.
So, we come to the end, and we’re asking the same question: “Is health insurance tax deductible for small businesses? The answer is yes, as long as we remember that most health insurance “costs” come from employees, not owners.
Final Takeaways for Business Owners
Here’s a good list to follow:
- Ensure your business is structured correctly as a legal entity or structured for favorable tax treatment.
- Always look for a beneficial tax credit to defray the cost of health insurance.
- Provide good healthcare options for your employees. It’s the right thing to do; it’s necessary to retain top talent; and health care is cheap compared to other business processes. (Fact: The cost of onboarding new employees averages around $4,000, which is less than the cost of the employer contribution towards many single plans.)
Tax savings and strong leadership go together more than we think. So keep your employees healthy and save your cash. Everybody wins.
Jeremy A. Johnson, CPA