Health insurance is one of the largest costs for self-employed people. The self-employed health insurance deduction lets many of them deduct premiums for medical, dental and qualifying long-term care coverage for themselves, their spouse and dependents as an adjustment to income. The IRS covers the rules in the instructions for Form 7206, Self-Employed Health Insurance Deduction.

Who can claim it

The deduction is generally available to:

  • Sole proprietors with a net profit
  • Partners receiving self-employment earnings from the partnership
  • More-than-2% shareholders of an S corporation, when the premiums are handled through the corporation as described below

The eligibility tests

You cannot take the deduction for any month in which you were eligible to participate in a subsidized health plan maintained by an employer of you or your spouse, even if you did not enroll. The deduction is also limited to the earned income from the business under which the plan is established.

How S corporation owners claim it

For more-than-2% shareholders, the S corporation pays or reimburses the premiums and includes them in the shareholder's W-2 wages, generally in Box 1 but not in Social Security and Medicare wages when certain conditions are met. The shareholder then claims the deduction on their personal return. If the premiums never pass through the corporation's payroll, the deduction can be lost. That is a year-end payroll item worth checking in early December; see Form 1120-S.

Partners

A partnership that pays premiums for a partner generally treats them as guaranteed payments to that partner, who can then claim the deduction if eligible.

It is not a business expense on Schedule C

For sole proprietors, the deduction is taken on the individual return as an adjustment to income, not on Schedule C. It reduces income tax but not self-employment tax.

Records to keep

  • Premium statements showing the policy holder and covered people
  • Proof of payment, ideally from a business account or clearly identified
  • For S corporations, the payroll records showing premiums included in wages

In your bookkeeping

Owner health premiums paid from a sole proprietor's business account are recorded as owner draws, not expenses, so Schedule C is not overstated. For S corporations, we post premiums to an officer health insurance account and coordinate with payroll before the final run of the year. Our payroll services handle the W-2 reporting, and our guide to self-employment tax explains why the deduction does not reduce it.

Recording premiums

For sole proprietors, premiums paid from the business account are generally recorded as owner draws, because the deduction is taken on the individual return. For S corporations, record premiums for more-than-2% shareholders as described in IRS guidance and include them in the shareholder's W-2.

Coordination with premium tax credits

If you received advance premium tax credits for Marketplace coverage, the deduction and the credit interact, and the calculation can be complex. Your preparer will need Form 1095-A.

Key terms

Definitions for terms used in this guide, from our small business glossary:

  • Debits and Credits: Debits and credits are the two sides of every bookkeeping entry; each account type increases on one side and decreases on the other.
  • Guaranteed Payments: Guaranteed payments are payments a partnership makes to a partner for services or use of capital, regardless of profit.
  • Self-Employment Tax: Self-employment tax is the Social Security and Medicare tax paid by people who work for themselves, calculated on net earnings from self-employment.