The Weeds of the Tax Treatment of Health Insurance for Self Employed

The blog has had a lot on the tax treatment of employer provided health insurance the last few days, and we (Austin, Aaron and myself) were chatting about the details of the tax treatment as it applies to the self-employed, and I pulled together a few details. The short version is that persons getting insurance from an employer as part of a benefit package (around 160 Million persons) get the most subsidy, with the self-employed (around 4 Million taking the deduction noted below) getting some subsidy (via deductibility of premiums), but less than those getting insurance from an employer. Persons buying health insurance with after tax dollars get no tax preference (about 14 Million persons with such policies). Here is a brief overview of how it works for self employed persons.

For the purpose of calculating income taxes owed, the self-employed health insurance deduction was began in 1987 and made permanent 10 years later. The value of the deduction rose over time (started at 25% of premiums) until the full value of health insurance premiums paid by self-employed persons were made fully deductible in 2003. However, this still does not equalize the tax treatment of health insurance premiums as compared to those getting coverage from an employer, as self-employed health insurance premiums are still not deductible in payroll tax calculations, while they are deductible for larger businesses.

Under the current tax code, corporations are able to deduct health insurance premiums as a business expense and thus forego FICA (Social Security and Medicare) taxes on these expenses. In contrast, Schedule C tax filers – including sole-proprietors, partners in partnerships, LLC owners and S Corporation owners – must pay for their health insurance premiums out of earnings that are subject to the 15.3 percent FICA self-employment tax. There are other differences such as a self-employed person gets no value from their premium deduction if their business shows a loss for a year, while an employee of a business that loses money in a given year still gets the full value of the premiums paid by their employer as tax free income. Working out exactly how much subsidy a self-employed person receives as compared to one receiving insurance from an employer gets complicated.

If you REALLY want to know more here are a few links: Turbotax with general details, and a link describing how a one-year provision in the 2010 tax code lessened the difference for tax year 2010. Edit: here is a relevant IRS tax form that I meant to include last night.



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