If your employer pays for your health insurance, you don't have to pay federal income taxes on those premiums. If you're self-employed, Uncle Sam evens things out by allowing you to write off your premiums as well. However, there are limits on both of whose expenses you can include and how much you can deduct.
Sole Proprietorship as an Entity
The IRS treats a sole proprietor and the business as one taxpaying entity: the sole proprietor is both the employer and the employee. When it comes time to file taxes, sole proprietors must calculate their net self-employment income using Schedule C. On this form, you get to deduct your operating expenses to figure your net-self-employment income, which is the amount you have to pay self-employment taxes on and report on your Form 1040 tax return.
Only your medical insurance premiums qualify for the self-employment medical expenses deduction. You can also include medical insurance premiums for your spouse, your dependents and any of your children who are under age 27 at the end of the year, even if that child is not your dependent. Your children includes your sons, daughters and stepchildren. Other medical expenses, such as out-of-pocket costs, do not qualify. You can include these other costs in the medical expenses deduction available to all taxpayers. However, the general medical expenses deduction only allows a deduction for expenses greater than 7.5 percent of your adjusted gross income during the tax year, and 10 percent of your Adjusted Gross Income the next year and subsequent years.
Limitated to Profits
The amount of the self-employed medical insurance premiums deduction can't exceed the amount of your self-employment income for the year, as figured on Schedule C. For example, if you have $8,000 in self-employment income for the year and the medical insurance premiums for yourself, your spouse and your dependents are $12,000, you're limited to taking an $8,000 deduction. However, if you have the same $12,000 in premiums, and $50,000 in self-employment income on Schedule C, you can deduct the entire $12,000.
Claiming the Deduction
Schedule C, the form used to report self-employment income and expenses, does contain a line for employee benefit programs, you only include medical insurance you pay for other employees, not yourself, on that line. Instead, sole proprietors report the deduction for their medical insurance on line 29 of Form 1040. If you have other medical expenses besides insurance, you can use those expenses for the medical expenses deduction on Schedule A. However, you can't count your insurance premiums for both deductions.
Read More: Deduction Categories for a Sole Proprietor
Health Reimbursement Account Basics
Health reimbursement accounts are set up by employers to pay for medical expenses of employees. Payments made through a health reimbursement account aren't taxable income to the employee, but the payments are deductible expenses for you as the sole proprietor. Health reimbursement accounts must be funded solely by the employer, meaning the funding must be in addition to the employee's compensation, and the reimbursements can only be provided for verified medical expense. The expenses that qualify are those that could be deducted as part of the medical and dental expenses deduction, including checkups, preventative care, surgeries and other treatments for the employee, the employee's spouse, the employee's dependents and the employee's children under 27.
Health Reimbursement Accounts and Sole Proprietors
As a sole proprietor, you're ineligible to set up a health reimbursement account for yourself. However, you can set them up for your employees. If your spouse works for you, your spouse can use her health reimbursement account for your expenses because you are her spouse. For example, if you hire your spouse and set up a health reimbursement account for her, she can use the money for both her medical expenses as well as your expenses. However, if you have multiple employees, you have to set up a health reimbursement account for all of them. In addition, even if your spouse is your only employee, you must be able to show that your spouse actually performs services for the business.
- Internal Revenue Service: Publication 502: Medical and Dental Expenses
- Internal Revenue Service: Topic 502 - Medical and Dental Expenses
- Internal Revenue Service: Health Insurance Tax Breaks for the Self-Employed
- Internal Revenue Service: Schedule C Instructions
- Internal Revenue Service: Form 1040 Instructions
- Internal Revenue Service: Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."