Self-employed independent contractors, referred to as sole proprietors by the Internal Revenue Service, enjoy their fair share of tax advantages. One of the nicest might be the health insurance tax deduction that the IRS reserves exclusively for them. It’s not a deduction in the typical meaning of the term – it’s actually better than that. It’s technically an adjustment to income, and that’s a good thing indeed.
You literally don’t pay any income tax on adjustments to income, and this one is equal to the portion of your earnings you use to pay your health insurance premiums. Subtracting adjustments to income results in your adjusted gross income or AGI, and a lesser AGI can qualify you for other tax breaks.
The Qualifying Rules
Of course, the Internal Revenue Service imposes multiple qualifying rules whenever it offers tax breaks. You can’t just hang out your shingle, declare that you’re self-employed and claim the self-employed health insurance deduction for your health care. Your business must actually show a net profit on Schedule C of your tax return.
Neither can you say, “No thanks,” to paying for any other insurance coverage that you might qualify for, paying for your own so you can claim this adjustment to income. You won’t qualify for the self-employed health insurance tax deduction if you additionally hold down a regular job and your employer is willing to provide to you with insurance coverage. You’re obligated to accept that perk rather than purchase your own self-employed policy.
The same applies if you’re married and you could be covered on a policy provided to your spouse through their employer. And COBRA insurance availability will disqualify you, too, because that medical insurance is an offshoot of your previous employment.
On the bright side, a single month of available employment coverage won’t steal your self-employed health insurance adjustment to income for the whole year. You can still claim the deduction for premiums paid from February through December if you had alternate options in January, or in any other number of months. You can claim it for a single month if that’s the only period of time when you had to pay for your own coverage.
What Coverage Is Eligible?
The rules for qualifying coverage are rather generous. Insurance policies covering medical, vision and dental care are obviously included, but so are certain long-term care policies, subject to an additional rule. Medical care policies can cover your child up to 27 years of age, even if they’ve aged out from qualifying as your dependent for other tax purposes. They can cover your spouse and younger children as well.
You can purchase the health insurance policy personally, or you can do it in the name of your business.
The Rule for Long-Term Care Policies
An additional rule applies to long-term care policy coverage. Yes, this coverage is eligible for the self-employment health insurance adjustment to income, but it’s one of those issues where youth is not on your side. Older is better.
These premiums can be limited depending on your age. For example, you can only deduct $430 of payments you make toward this coverage if you’re age 40 or younger as of 2020. This increases to:
- $810 up to age 50
- $1,630 up to age 60
- $4,350 up to age 70
- $5,430 if you’re age 71 or older
These limits are per year, not per month.
Other Business Entities Can Qualify, Too
You’re not limited to operating as a sole proprietor or independent contractor in order to claim this tax break. The scope of the self-employed health insurance deduction reaches to a couple of other business entities as well.
You can claim it if you’re a partner in a partnership or you’re a member of an LLC. These types of businesses don’t technically pay income taxes of their own. Their profits and losses trickle down or “pass through” to their partners and members, who must then report the income or losses on their own personal tax returns. This rule qualifies them for the health insurance adjustment to income.
You might also qualify if you own more than 2 percent of an S corporation and you were paid wages, but check with a tax professional to be sure because various complicated rules apply here.
How Much Is the Deduction?
Health insurance premiums have been 100 percent deductible for the self-employed since 2003, which isn’t the case for taxpayers who work for an employer. You can deduct $500 a month if you spend $500 a month on qualifying insurance premiums – the full 100 percent of what you spent – but subject to that net income rule.
In other words, you can’t claim a $6,000 deduction for paying $6,000 in premiums if your business’s net income for the year was just $5,000. That other $1,000 can potentially go unused, although you have one more option to try to claim a portion of that as well.
The IRS imposes one more limitation here. You can’t add their net profits together to reach 100 percent deductibility of your premiums if you’re lucky enough to have two or more self-employment gigs. The adjustment to income isn’t based on the net profit you show on Schedule C with your Form 1040 tax return for all your businesses collectively. You would have to apply the adjustment to income to just one of your enterprises, whichever has sufficiently high net income to take advantage of the 100-percent deduction.
The Advantages of Adjustments to Income
Your AGI is a direct reflection of your taxable income. You would be taxed on only $50,000 of earnings if your gross income is $75,000 but you’re eligible to claim $25,000 in these income adjustments “above the line.” Other expenses that fall into this category include a portion of your self-employment tax, alimony you might have paid under a divorce decree or order that was entered prior to 2019, student loan interest and contributions you made to an IRA.
Qualifying for numerous other tax breaks can depend on your AGI. You can be prohibited from claiming them if your AGI is too high. Some of these affected deductions and credits include:
You can then additionally itemize other deductions or claim the standard deduction for your filing status after you arrive at your AGI, further reducing the portion of your income that you have to pay taxes on.
Read more: What Are Self-Employed Taxes?
How to Claim the Deduction
You must file Schedule 1 with your tax return to claim the self-employed health insurance adjustment to income, but this isn’t really a challenge. Simply enter the total of your qualifying premiums on line 16 in Part II of the tax schedule, then transfer the total of Part II, found on line 22 of Schedule 1, to line 10a of your Form 1040 tax return. Submit Schedule 1 with your tax return.
That’s it. You don’t have to deal with this deduction on your Schedule C, which you’d also have to file as a self-employed taxpayer to report your gross income from self-employment less certain allowable business expenses. Your health insurance is a personal expense, not a business expense. The downside to this is that the deduction won’t reduce your self-employment taxes, but only your income tax liability.
Self-Employed vs. Employed Taxpayers
Compare this adjustment to income to the deduction you would be entitled to claim for insurance premiums if you worked for someone else. You could still deduct your health insurance premiums in this case, but only those plus your actual medical expenses that exceed 7.5 percent of your AGI. Yes, your AGI factors in here, too. Higher isn’t better.
For example, your deduction would be limited to $2,250 of that $6,000 you spent on insurance premiums all year if your AGI was $50,000. The 7.5 percent of your AGI threshold works out to $3,750, and you can only claim a deduction for the costs of your premiums in excess of this amount if you're not self-employed.
You’d additionally have to itemize to take advantage of this tax break, which means not claiming the standard deduction for your filing status. And standard deductions increased pretty significantly under the terms of the Tax Cuts and Jobs Act, effectively doubling in 2018. You’re entitled to a standard deduction of $12,400 as of the 2020 tax year if you’re single, so you’d need at least $12,401 in total itemized deductions to make itemizing worth your while. Otherwise, you’d be paying tax on more income than you have to.
The 7.5 percent threshold is slated to increase to 10 percent in 2021, making claiming this deduction even more difficult for employed taxpayers.
Read more: Are a Prior Year's Medical Bills Tax Deductible?
You Can Claim Both
Claiming the medical expense itemized deduction in addition to claiming the self-employed health insurance adjustment to income might be an option if your business didn’t produce enough in the way of net profit to cover all the insurance premiums you paid all year. But, of course, you’d need enough in the way of itemized deductions overall to exceed the available standard deduction for your filing status.
There’s no rule that says you can’t deduct up to the amount of your net business profit as an adjustment to income on Schedule 1, then apply anything that's left over to an itemized deduction on Schedule A, the tax form you’d have to file if you were going to itemize. And you can include any unreimbursed medical expenses you paid on Schedule A as well, increasing the odds that you can surpass that 7.5 percent of your AGI when everything’s added together.
There’s an important caveat here, however. You can’t deduct $5,000 of your insurance premiums as a Schedule 1 self-employed health insurance adjustment to income, then claim the full $6,000 in premiums as an itemized deduction on Schedule A as well. That’s double-dipping. You’re limited to claiming the first $5,000 as a self-employed adjustment to income, then applying the $1,000 balance to your itemized medical expenses deduction on Schedule A.
- IRS: Topic No. 502 Medical and Dental Expenses
- Gusto: What’s the Self-Employed Health Insurance Deduction?
- HealthInsurance.org: Self-Employed Health Insurance Deduction
- NOLO: The Self-Employed Health Insurance Deduction – A Valuable Personal Deduction
- Shared Economy Tax: How to Claim the Self-Employed Health Insurance Deduction
- IRS: Schedule 1 Additional Income and Adjustments to Income
- Congressional Research Service: Tax Deductions for Individuals – A Summary
- NOLO: How Partnerships Are Taxed
- Long Term Insurance Partner: 2020 Long Term Insurance Tax Deduction
- TurboTax: Deducting Health Insurance Premiums If You’re Self-Employed
- IRS. "Topic No. 502 Medical and Dental Expenses." Accessed Oct. 17, 2020.
- IRS. "Publication 502 Cat. No. 15002Q: Medical and Dental Expenses (Including the Health Coverage Tax Credit): For Use in Preparing 2017 Returns." Pages 2-3. Accessed Oct. 17, 2020.
- Congressional Research Service. "Individual Tax Provisions (“Tax Extenders”) Expiring in 2020: In Brief." Page 8. Accessed Oct. 16, 2020.
- IRS. "Definition of Adjusted Gross Income." Accessed Oct. 17, 2020.
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- Tax Policy Center. "How Does the Tax Exclusion for Employer-Sponsored Health Insurance Work?" Accessed Oct. 17, 2020.
- IRS. "Publication 535 Cat. No. 15065Z: Business Expenses: For Use in Preparing 2019 Returns." Page 23. Accessed Oct. 17, 2020.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.