IF YOU’RE A sole proprietor, partner, or member of a limited liability company (LLC), you’re considered self-employed for tax purposes. As such, you probably have to pay your own health insurance premiums. The good news is you can probably deduct them on page 1 of Form 1040, which is a favorable deal compared to what happens to everyone else who pays their own premiums. Here’s the scoop on this self-employment tax break.
The benefits of page 1 deduction treatment
The general rule says individuals must combine their health insurance premiums with other out-of-pocket medical expenses. To the extent the total exceeds 7.5% of adjusted gross income (AGI), you can claim the excess as an itemized deduction. Unfortunately, the 7.5%-of-AGI hurdle can be difficult — if not impossible — to clear. And even if you do clear it, you get no tax savings unless you itemize.
Thankfully, eligible self-employed individuals are allowed to deduct their health insurance premiums, including payments for dental coverage, on page 1 of Form 1040 (on line 29 of the 2009 version of the form). The page 1 deduction reduces your taxable income (and your tax bill) whether you itemize or not. And you don’t have to worry about the 7.5%-of-AGI hurdle. Finally, the page 1 deduction lowers your AGI, which lowers the odds that you’ll fall victim to all those nasty phase-out rules that can reduce or eliminate valuable tax breaks (like the child tax credit, the two higher-education tax credits, and many other goodies).
If you’re eligible, you can claim the beneficial page 1 deduction for heath premiums to cover you, your spouse, and your dependents. Here are the rules.
1. Eligibility Is Determined Month-by-Month
You can only claim the page 1 deduction for premiums paid for months during which you’re ineligible to participate in any subsidized health plan offered by an employer of you or your spouse. For instance, say you did not participate in any employer-subsidized plan for the last nine months of the year because you quit your job to go into business for yourself as a sole proprietor. As long as you also did not participate in any subsidized plan offered by your spouse’s employer, you’re good to go for the page 1 deduction deal (assuming no problem with the earned income limitation explained next).
2. Earned Income Limitation
The page 1 health insurance deduction can’t exceed the earned income from the self-employed business activity for which you establish the health coverage. For example, if you have a sole proprietorship with Schedule C net taxable income of $10,000, your page 1 deduction can’t exceed $10,000. If you have a farm with Schedule F net income of $8,000, your page 1 deduction can’t exceed $8,000. You get the idea.
The IRS says you can take out the health insurance in the name of your business or (more likely) in your own name. In the latter case, please put a piece of paper in your tax records file stating that you established the health coverage for a specific self-employed activity (for example, your Schedule C consulting operation).