Health insurance premiums paid on behalf of a shareholder greater than 2%, are deductible and reportable by the S corporation as wages for income tax withholding purposes on the shareholder's Form W-2.

These benefits are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes. The additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement issued to the shareholder, but would not be included in Boxes 3 and 5 of Form W-2.

A 2% shareholder is eligible for a deduction in arriving at Adjusted Gross Income (AGI) for amounts paid during the year for medical care premiums if the medical care coverage is established by the S corporation, and the shareholder meets the other self-employed medical insurance deduction requirements. A deduction used to arrive at AGI is referred to as an above-the-line deduction. However, if the shareholder or the shareholder’s spouse is eligible to participate in any subsidized health care plan, then the shareholder is not entitled to the above-the-line deduction.

A medical plan can be considered established by the S corporation if the S corporation paid or reimbursed the shareholder-employee for premiums and reported:

  • The premium payment
  • Reimbursement as wages on the shareholder-employee’s W-2

Citation: http://www.irs.gov/Businesses/Small-Businesses--Self-Employed/S-Corporation-Compensation-and-Medical-Insurance-Issues