If you are a self-employed individual who paid Medicare premiums in the past and did not take an above the line self-employed heath insurance deduction for these payments, you have the option to amend your prior year tax returns within the statute of limitations. Below are advantages, disadvantages and considerations to consult with your tax advisor.
Prior to 2010, self-employed individuals were not allowed to take an above the line self-employed health insurance deduction under Section 162(l) for Medicare premiums. Health insurance is only considered deductible under the statute if it is established by your trade or business. The purpose of the health insurance deduction is to equalize the treatment of owners of corporations who are allowed to exclude health care benefits as a fringe benefit and self employed individuals who cannot. Since Medicare is established by the Federal government the IRS did not consider Medicare premiums deductible as self employed health insurance. Recently the IRS reversed their opinion on the matter referencing Notice 2008-1. Notice 2008-1 states that as long as the self employed individual’s business ultimately pays for the health insurance and follows certain reporting requirements, the health insurance premium payments are deductible as above the line for the self employed individual. The Office of Chief Counsel IRS Memorandum extended Notice 2008-1 to apply to self employed individuals who pay Medicare premiums. Now all Medicare premium parts-A, B, C and D-paid by the self-employed individual for themselves, their spouse and dependents are deductible as self employed health insurance. The premium payments need not be paid directly by the self-employed individual. For example, the S corporation of a more-than-2% shareholder can make the payments directly and the self-employed individual is entitled to the deduction.
- Taxpayers have the potential to benefit from significant tax savings. Taxpayers who filed married filing jointly and had a MAGI above $428,000 could have paid up to $4,243 in Medicare Part B premiums during the 2010 tax year. The taxpayer and spouse could potentially save $2,970 ($4,243 x 2 x 35%).
- Since Medicare premiums reduce the taxpayer’s AGI, itemized deductions with AGI limitations may increase, resulting in even greater tax savings.
The IRS could disallow this deduction. Although, the Office of Chief Counsel IRS Memorandum is the IRS’s opinion it is not the law and cannot be relied upon.
Below are a few limitations to consider with regard to the self employed health insurance deduction.
- The deduction is limited to the taxpayer's earned income. Therefore, if the taxpayer's company did not make a profit, this deduction will not be beneficial to the taxpayer. This could pose a specific problem for more-than-2% shareholder employees, because Medicare Wages are considered earned income for purposes of the earned income limitation. A retired person or part-time person may have little to no Medicare Wages and therefore would be significantly limited in the amount they can deduct. Please keep in mind the Medicare premiums are reported as Federal wages, but not Medicare Wages on Form W-2.
- In order for the Medicare premium payments to be deductible under Section 162(l) the medical plan must be established by the taxpayer’s business. If the taxpayer's Medicare premium payments were not properly administered and accounted for by their business, then their premium payments are not considered established by their business and are not deductible. Most self employed individuals pay Medicare premiums from their Social Security benefits. In this case the business will need to reimburse the taxpayer for the premiums paid. In addition, the business must report the income on the self employed individual’s Form W-2 or Schedule K-1 depending on whether the self employed individual is a more-than-2% shareholder or partner. The self employed individual is responsible for reporting the income on their Form 1040.
- For taxpayer's in the Alternative Minimum tax, the deduction may be limited depending on if the taxpayer has other AMT adjustments that impact their taxable income.
- When the taxpayer's AGI decreases as a result of the deduction, the ceiling for charitable contributions lowers which may lessen the charitable deduction benefit in the current year.
Keeping these items in mind, self employed individuals should consult their tax advisor to determine whether or not it makes sense to amend their prior year tax returns. This is also a critical time for self-employed individuals to engage in tax planning. Self employed individuals should evaluate whether or not they are in compliance with the requirements needed to deduct their Medicare premium payments in the future. In addition, they should consider the impact of a lower AGI on their future itemized deductions. Finally, self employed individual should prepare for how a reduction in AGI will affect them in light of future tax laws such as the Medicare contributions tax set to take effect in 2013.