Tax Research Memo

Date: July 13, 2011

To: Tax File

From: Purvi Amin

Facts: Bob McDonald obtained an accident and health insurance plan in his name in 2009. The plan provides coverage for him and his wife and two children. He makes all the premium payments for the plan and gives proof of the payments to Late-Night, the company that he holds 50% market share of. Late-Night then reimburses Bob for the payments as wages on Bob's W-2 Form for the tax year. Bob reports these wages as gross income on his own tax return. Bob's earned income from Late-Night exceeds the amount of premiums paid by his employer or his spouse's employer and has asked his CPA if he can get a deduction on his tax return.

Issue: Can Bob take a deduction on his tax return for the premiums paid?

Conclusion: Since Bob's earned income exceeds the amount of the premiums paid for the health coverage, he can receive a deduction on the basis of IRC SECTION 162 (I) (2) (A). Revenue ruling 91-26, 1991-1 CB 184 and Notice 2008-1, I.R.B. 2008-2 support this conclusion.

Discussion: IRC Sec. 162 (I) states special rules for Health Insurance Costs of Self Employed Individuals. IRC Sec. 162 (I)(1) allows a deduction in the case of a taxpayer (Bob) who is an employee in the amount equal to the amount paid during the taxable year for insurance which constitutes medical care for the taxpayer, his spouse, children and dependents. IRC Sec. 162(1)(2)(A) provides a limitation that no deduction shall be allowed to the extent that the amount of such deduction exceeds the taxpayer's earned income derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established. This does not apply to Bob because his earned income exceeds the amount of deduction for that given year. Under IRC Sec 162 (1) (2) (B) a taxpayer cannot receive a deduction if he is eligible for any subsidized health plan maintained by any employer of the taxpayer (Bob) or his spouse. From the facts given, we can assume his wife is not eligible for a subsidized plan and since he isn't either, he does not fall under this limitation. IRC Sec. 162(I) (5) applies to S corporation shareholders who owns on any taxable year 2% or more of the outstanding stock as stated in IRC Sec. 1372(b). Since Bob owns 50% of the outstanding stock he falls under this section and therefore would receive a deduction.

In revenue ruling 91-26, 1991-1 CB 184, the IRS rules that accident and health insurance premiums paid by an S corporation on behalf of a 2-percent shareholder-employee are not excludable from gross income. However, since the requirements of Sec. 162 are met as explained in the previous paragraph, the shareholder-employee may deduct the cost of the premiums.

Notice 2008-1, I.R.B. 2008-2, also states that a