If you are self-employed and pay Medicare premiums, you may now be able to deduct the cost of those premiums on your tax return.
For many years, the IRS has said that Medicare premiums cannot qualify as self-employed health insurance. In fact, in 1995, the IRS issued a Field Service Advisory firmly maintaining this position and indicating the reason Medicare does not qualify is because it is a federal program that cannot be considered established with respect to the taxpayer’s trade or business. As one would expect, the IRS Form 1040 instructions and Publication 535 (Business Expenses) clearly reflected this conclusion.
Yet, a couple of years ago, the IRS very quietly did an about-face starting with 2010 tax returns. Since then, the instructions and publications simply state that Medicare Part B qualifies for the deduction; however, the IRS included no explanation for this change.
In July of this year, the IRS confirmed the taxpayer-friendly change and issued more complete information. In a Chief Council Advice, the IRS said that Medicare premiums do indeed constitute health insurance for business owners who qualify for the self-employed health insurance deduction. The reason? Medicare constitutes medical care insurance as defined by the Internal Revenue Code for this purpose.
The IRS added that all Medicare premiums (not just Part B) qualify as medical care coverage, and that the deduction includes premiums covering the self-employed taxpayer’s spouse and qualifying children. (The IRS has recently back tracked and has indicated premiums paid for a spouse cannot be included unless the spouse is self-employed.) The Advice goes on to say that in the case of a partner in a partnership or a more-than-2% shareholder-employee in an S corporation, the partner or employee may pay the premiums directly and be reimbursed by the partnership or employer or the partnership or corporation may pay the premiums directly. In either case, the partnership must report the premiums as guaranteed payments to the partner, who must report the guaranteed payments as gross income on his or her Form 1040. The S corporation must report the payments as wages on the shareholder-employee’s Form W-2, who must report them as gross income on Form 1040.
There are a few instances where the deduction would not be allowed:
- If the amount of the deduction exceeds the earned income derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established.
- During any months in which the taxpayer is eligible to participate in any subsidized health plan maintained by an employer of the taxpayer or of the spouse of the taxpayer.
The Advice says that taxpayers who previously failed to claim Medicare premiums as a self-employed health insurance deduction can amend prior year returns to claim the deduction.
Please contact us for additional information.