The IRS recently issued a Chief Counsel Memorandum clarifying when a family member of a 2% shareholder in an S corporation is entitled to a deduction under Section 162(l) of the Internal Revenue Code (the "Code") for health plan insurance premiums paid for coverage provided to the family member by the S corporation. Chief Counsel Memorandum 201912001 (March 22, 2019).
Background. For benefit plan purposes, a 2% or more shareholder of an S corporation is treated like a partner in a partnership. Therefore, if the 2% shareholder-employee is covered by a health plan of the S corporation, the S corporation will include the health insurance premiums paid in the shareholder's income and they will be reported as income on Form W-2. To give the 2% shareholder equivalency with common law employees, the 2% shareholder is allowed to take an "above the line" deduction on his or her individual Form 1040 for the amounts paid by the S corporation for health insurance coverage for the shareholder-employee and his or her family members.
To meet the requirements for the deduction under Code Section 162(l), the health plan must be established by the S corporation. The plan is considered to be established by the S corporation if either:
- The S corporation makes the premium payments for the health insurance policy; or
- The 2% shareholder makes the insurance premium payments and the S corporation reimburses the shareholder upon receipt of proof of payment.
Issue Addressed by the IRS. The question posed to the IRS was whether a family member, who is deemed to own stock under the family attribution rules, is entitled to the deduction under Code Section 162(l) for the amount of the health insurance premiums paid on his or her behalf by the S corporation. The family attribution rules provide that an individual is deemed to own stock owned, directly or indirectly, by or for his or her spouse, children, grandchildren and parents.
For example, assume Father owns 100% of an S corporation. Daughter is employed by the S corporation and, under the family attribution rules, is deemed to own 100% of Father's stock. Daughter is, therefore, considered to be a 2% shareholder. The S corporation provides a group health plan to all employees, including Daughter. The premiums paid by the S corporation on behalf of Daughter for the health plan coverage will be included on her Form W-2 as income.
In the Chief Counsel Memorandum, the IRS concluded that, if the conditions of Code Section 162(l) are met, Daughter is entitled to take a deduction on Form 1040 for the health plan premiums paid by the S corporation on her behalf.
This conclusion in the Chief Counsel Memorandum is welcome news for family members who work for S corporations owned by another family member, as they will be permitted to take the deduction for insurance premiums paid for health plan coverage that is included in their income.
A Chief Counsel Memorandum is written advice issued by the Office of Chief Counsel in response to an internal request for guidance from the IRS. It is not considered substantial authority or binding precedent, but provides insight on the IRS position on a particular issue. We recommend that you consult with qualified tax counsel on this or similar issues.
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