It’s not that hard to figure out what the IRS is going to do next. For one thing, they tell us tax pros every year where they are going to focus their attention. But, if you’re paying attention you can figure it out a year or more in advance and that gives you time to prepare.

One of the areas that we’ll see a lot more audits in is S Corporations. And one of the problems areas is going to be medical insurance deductibility.

It’s confusing, and doesn’t make a lot of sense, but here’s how medical insurance deductions work for an S Corporation according to IRS issued Notice 2008-1. (http://www.irs.gov/pub/irs-drop/n-08-01.pdf)

In short, medical insurance paid under individual medical insurance plans may be deductible “above the line” if the following conditions are met:

1. The corporation must establish a “plan” for the payment of medical insurance premiums on behalf of the shareholder-employee.
2. The corporation must either pay the premiums for the plan, or reimburse the employee-shareholder for the premiums paid after being provided proof of premium payment to the S corp.
3. Premiums so paid or reimbursed on behalf of the shareholder-employee MUST BE ADDED TO W-2 BOX 1 WAGES. These premiums should be EXCLUDED from Box 3 Social Security Wages and Box 5 Medicare Wages (thus they are exempt from FICA taxes completely).
4. On the 1120S for the S corporation, the corporate tax return will include a deduction for wages/compensation paid which includes the medical insurance paid on behalf of the shareholder employee.
5. On the shareholder-employee’s 1040 an above the line deduction will be taken for the medical insurance paid by the corporation which were added to the W-2. In Notice 2008-1 the IRS states that if this treatment is not followed, the medical insurance deduction “above the line” will be disallowed and the deduction will be moved to Schedule A. If this happens, the value of the deduction is generally severely limited due to the 7.5% threshold that must be exceeded before medical expenses are allowed.

ACTION ITEMS TO TAKE ADVANTAGE OF THIS DEDUCTION:

1. Document the existence of your corporation’s “plan” by making note of it in your annual minutes.
2. If you have paid the medical insurance individually, gather up all of your medical insurance payments for 2009 and submit a reimbursement to your corporation to reimburse yourself for those amounts. Post the reimbursement check to “Officer Wages” or similar gross pay expense account.
3. Contact your payroll company to provide them with the information necessary to include the medical insurance expense (directly paid by the corporation or reimbursed to the shareholder) in your final paycheck and your W-2 for 2009.

If you’ve already issued the W-2s (which you should have) you can create amended ones to correct the medical insurance issue.

If you’ve got an S Corporation, the IRS has its eye on you. And that means an audit. If the audits are anything like the brutal audit teams that have targeted Real Estate Professionals then we can expect some bad times ahead for S Corporations.

Be prepared! Our March 23rd USTaxAid coaching session http://www.usataxaid.com/coaching is focusing on Filing Your S Corporation tax return – safely and with the most legal tax deductions you can take.