Understanding The Health Insurance Deduction for Self Employed

Many years taxpayers miss potential tax deductions that could save them hundreds of dollars in overpaid taxes. Today I want to bring to you attention one tax deduction that many self-employed entrepreneurs missed this year; the special provision for health insurance deduction of 2010. The Small Business Jobs and Credit Act of 2010, provided a one-year tax provision where self-employed (sole proprietorship, single-member LLC, or sole-owner S-corp), can deduct their health insurance expenses for 2010 against their self-employment tax. This will make a huge difference for self-employed entrepreneurs in lowering their taxes for the 2010 tax year. This provision addresses a fundamental unfairness against the self-employed and the treatment of the health insurance costs; self-employed individuals cannot deduct the full cost of health insurance premiums as a business expense on their payroll taxes, as other business entities can do.

This is a special rule for 2010 only. For 2011 and later years, the health insurance deduction will revert back to being deducted only against the income tax, unless Congress decides to extend this particular tax break.

Here is an example on how this tax provision will affect self-employed this year:

Let's say Sandy, a freelancer, makes $60,000 in net income and pays $6,000 for health insurance. In other tax years, Sandy would pay income tax on $54,000 and self employment tax on $60,000. However, in 2010 Sandy will pay income tax and self employment taxes on $54,000. This provides Sandy a tax saving of $459 in her 2010 income tax return.

Make sure to ask your tax preparer about taking the deduction when you file your tax returns next year. If you have already filed, have your tax return reviewed to determine if the deduction was missed (you may have to file an amended tax return to claim the missed deduction). Here are a couple of caveats:

1. You must buy your own insurance (rather than relying on a spouse's coverage or being uninsured).

2. The deduction phases out above a $106,800 annual income limit.

3. The provision is specifically geared for those who file a 1040 Schedule C business income tax form or a Schedule E earned income tax form.

4. If you are reporting a loss from your self-employed activity, then you are not eligible to deduct your health insurance costs since this particular deduction is limited by your self-employment income. You can however still claim the health insurance expenses as an itemized medical deduction on your Schedule A.

5. The new deduction does not apply to health insurance coverage that you may provide for any employees you have.

For more information on that tax credit is available at the IRS website.