Another Confusing Issue
This post is directed to self-employed writers, editors, illustrators, researchers and others in the publishing industry that file a Schedule C as part of their annual tax return (Form 1040). Self-employed persons may deduct the cost of health insurance (including long-term care coverage) they receive through their business but not as a business expense on Schedule C.
Where the cost of health insurance is deducted will, as usual, depend on a few variables. The best case scenario is that you get the full amount paid during the year as a deduction on Form 1040, page 1, line 29 as an adjustment lowering the page 1 total (adjusted gross income) and, thus, taxable income. This is called an “above-the-line” adjustment. For this to happen, however, you will need to overcome several barriers.
Even though your business pays the premiums for your (and your dependents) healthcare insurance, you cannot deduct those premiums on Schedule C as a business expense. Thousands of Schedule C’s contain this error (some intentionally, playing the audit lottery, and by others who are simply uninformed). The IRS automated analysis of Schedule C is sophisticated enough to catch this gaffe and will automatically lower your refund or increase your balance due or, in the alternative, generate correspondence to you on this issue and, perhaps, others on the same return. Only healthcare premiums for your employees, if any, may be deducted on Schedule C as employee benefits.
Factors Affecting Form 1040, page 1, line 29 Deductibility
1. The health insurance policy needs to be in the name of the business or in the name of the individual business owner.
2. You cannot take a deduction for self-employed health insurance if you (or your spouse) were eligible to participate in any employer subsidized health plan at any time during a month, even if you did not actually participate. You may have a split-year situation if you were employed for part of the year (with access to subsidized employer health insurance) and self-employed for part of the year.
3. To qualify, you must have a net profit for the year reported on Schedule C. In other words, if your Schedule C shows a loss, you may not deduct health insurance on Form 1040, page 1, line 29. Remember that your loss on Schedule C will not have used health insurance as an expense in that computation. If you have a net profit on Schedule C but it is less than your health insurance costs, you can only claim an insurance expense on Form 1040, page 1, line 29 to the extent of the net profit reported on Schedule C. Example: Your health insurance costs were $7,500 for the year and your Schedule C net profit is $4,000. Your Form 1040, page 1, line 29 deduction is limited to $4,000. The balance of your insurance premiums can be included as medical expenses on Schedule A (Form 1040), Itemized Deductions, if you itemize deductions. If Schedule C shows a loss, the full amount of your health insurance costs will go on Schedule A.
Effect on Self-Employment Tax
For tax years beginning before or after 2010, you cannot subtract the self-employed health insurance deduction when figuring net earnings for your self-employment tax from the business under which the plan is established.
If you qualify, this is a very valuable Form 1040, page 1 adjustment for the full (or even partial) amount of your health insurance premiums. If you take the standard deduction and do not itemize, you get both the standard deduction and the amount on Form 1040, page 1. If all or a portion of your health insurance premiums must be reported on Schedule A, the only deductible portion allowed there will be the amount that exceeds 7.5% of your adjusted gross income (the last line on Form 1040, page 1). If your adjusted gross income amounts to $40,000 and you are required to put all or part of your health insurance expenses on Schedule A, the amount reported there will be reduced by $3,000 ($40,000 X .075) before it is combined with your other itemized deductions.
For further information, check pages 18-21 of IRS Publication 535, Business Expenses.
© 2012 Gary A. Hensley