In Chief Counsel Advice 201912001 the IRS held that family members, who while not directly holding shares in an S corporation, are deemed to be 2% shareholders under the rules of §318 are allowed to claim the self-employed health insurance deduction under IRC §162(l) if they otherwise qualify.

Under IRC §1372, individuals holding 2% or more of the stock of an S corporation are treated as if they were partners for purposes of applying the employee fringe benefit income tax rules.  IRC §1372(b) expands that definition of shareholders to include those who would be deemed to hold such shares by attribution under IRC §318.

Under IRC §106, only employees are permitted to exclude the value of employer provided health insurance from their income.  Thus, partners treat the value of such insurance paid by the partnership as a guaranteed payment.  Under Announcement 92-16 the S corporation shareholder treats this amount that would have been a guaranteed payment as wages for income tax purposes.  Since the provisions of §1372 only apply to income tax provisions, these deemed wages are not subject to FICA, Medicare or FUTA taxes.

Family members are the first group included in the attribution rules of IRC §318.  IRC §318(a) defines that family group as follows:

(a) General rule

For purposes of those provisions of this subchapter to which the rules contained in this section are expressly made applicable—

(1) Members of family

(A) In general

An individual shall be considered as owning the stock owned, directly or indirectly, by or for—

(i) his spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and

(ii) his children, grandchildren, and parents.

The question raised in the advice was whether such family members, if employed by the S corporation and covered by a qualifying medical plan of the S corporation meeting the provisions of Notice 2008-1 could claim the self-employed health insurance deduction found at IRC §162(l).

IRC §162(l) allows a deduction in computing adjusted gross income for health insurance for self-employed individuals that meet certain conditions.  For an S corporation the provision of the insurance must meet the requirements found in Notice 2008-1.  And for all covered taxpayers, the taxpayer cannot be eligible to participate in a subsidized health plan maintained by an employer of the taxpayer or taxpayer’s spouse.[1]

The advice concludes that the deemed shareholder by attribution gets the same treatment as someone directly holding the S corporation stock.  The memorandum holds:

An individual who is a 2-percent shareholder of an S corporation pursuant to the attribution of ownership rules under § 318 is entitled to the deduction under § 162(l) for amounts that are paid by the S corporation under a group health plan for all employees and included in the individual’s gross income, if the individual otherwise meets the requirements of § 162(l).

[1] IRC §162(l)(2)(B)