Section 199A Self-Employed Health Insurance
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Section 199A Self-Employed Health Insurance
When comparing business activities on a Schedule C versus an S Corp election, one of the gripes is the reduction of the Section 199A qualified business income deduction in an S corporation because the payment of reasonable shareholder salary reduces net business income. As we have shown in Chapter 8 of our book, the reduction of Section 199A benefits is still eclipse by the savings of self-employment taxes in an S corporation. However, the final regulations for Section 199A have a little quirk which bolsters the benefits of an S corp election over garden variety LLCs reported on Schedule C. How? One of the answers is the Section 199A Self-Employed Health Insurance reduction in net qualified business income (QBI).
Let’s run through it, shall we?
Section 199A Final Regulations
The final regulations 1.199A for the Section 199A deduction clarified all kinds of things and the handling of the deductible portion of self-employment tax, self-employed health insurance and retirement plans for small business owners is one of them. Here is the code from 1.199A-3(b)(1)(vi)–
(vi) Other deductions. Generally, deductions attributable to a trade or business are taken into account for purposes of computing QBI to the extent that the requirements of section 199A and this section are otherwise satisfied. For purposes of section 199A only, deductions such as the deductible portion of the tax on self- employment income under section 164(f), the self-employed health insurance deduction under section 162(l), and the deduction for contributions to qualified retirement plans under section 404 are considered attributable to a trade or business to the extent that the individual’s gross income from the trade or business is taken into account in calculating the allowable deduction, on a proportionate basis to the gross income received from the trade or business.
Here is the key phrase- “For purposes of section 199A only, deductions … are considered attributable to a trade or business” and therefore reduce the qualified net business income for the calculation of the Section 199A. In other words, you would not have these expenses if you otherwise did not have a small business. Sure, you pay Social Security and Medicare taxes, pay health insurance premiums and contribute to a 401k plan with your W-2 job, but those “expenses” are attributed to your employment; same concept here.
What does all this mean? Before we get into that, the last sentence is crazy lawyer talk- “to the extent that the individual’s gross income from the trade or business is taken into account in calculating the allowable deduction, on a proportionate basis to the gross income received from the trade or business.” We’ll speculate on what this tidbit means since guidance specific to this phrase is not available or at least cannot found in our research databases (Thomson Reuters and Bloomberg).
| Scenario 1 | Scenario 2 | |
| Net Business Income on Schedule C | 100,000 | 100,000 |
| less Deductible Portion of SE Tax | 7,065 | 7,065 |
| less Self-Employed Health Insurance (SEHI) | 12,000 | |
| less 401k Plan / SEP IRA Contribution | 37,087 | |
| Net Business Income for Section 199A Calc | 92,935 | 43,848 |
| Section 199A Qualified Business Income Deduction | 18,587 | 8,770 |
| Delta in Section 199A Deduction | 9,817 |
| Delta in SEHI / 401k Deductions | 49,087 |
| Tax Savings @22% in Scenario 2 | 8,639 |
| No S | S Corp | |
| Biz Income | 100,000 | 100,000 |
| Salary / Officer Comp | 35,000 | 35,000 |
| SEHI, HSA, etc | 12,000 | 12,000 |
| Employer 401k / SEP IRA | 37,087 | 8,750 |
| ln | No S | S Corp | |
| 1 | Net Business Income Before Wages, etc. | 100,000 | 100,000 |
| 2 | less W-2 Wages, includes SEHI | 0 | 35,000 |
| 3 | less Self-Employment Tax / Employer Payroll Taxes | 7,065 | 1,760 |
| 4 | less Self-Employed Health Insurance (SEHI) | 12,000 | 0 |
| 5 | less Employer 401k / SEP IRA | 37,087 | 8,750 |
| 6 | Section 199A Qualified Business Income | 55,848 | 54,491 |
| Adjustments to Adjusted Gross Income / Net Business Income | |||
| 7 | less Social Security Tax | 5,726 | 0 |
| 8 | less Medicare Tax | 1,339 | 0 |
| 9 | less SEHI, 401k | 49,087 | 31,000 |
| 10 | Other Taxable Income | 0 | 0 |
| 11 | Adjusted Gross Income | 43,848 | 58,491 |
| 12 | Itemized / Std Deductions | 24,000 | 24,000 |
| 13 | Taxable Income Before Section 199A | 19,848 | 34,491 |
| 14 | Section 199A Net Biz Income | 11,170 | 10,898 |
| 15 | Section 199A W-2 Wage Limit | 0 | 17,500 |
| 16 | Section 199A Taxable Income Limit | 3,970 | 6,898 |
| 17 | Section 199A Benefit (lower of ln 14, 15, 16) | 3,970 | 6,898 |
| 18 | Marginal Income Tax Rate | 12% | 12% |
| 19 | Income Tax Benefit from Section 199A | -476 | -828 |
| 20 | plus Self-Employment Tax | 14,130 | 0 |
| 21 | plus Tax on Line 12 Delta (above) | 0 | 1,757 |
| 22 | plus Payroll Tax (Employee and Employer) | 0 | 3,519 |
| 23 | Net Tax After Section 199A Benefit | 13,653 | 4,448 |
| 24 | S Corp Benefit SE Tax Reduction Only | 10,611 | |
| 25 | S Corp Benefit Section 199A Only | -1,406 | |
| 26 | Net S Corp Benefit $ | 9,205 |
| ln | No S | S Corp | |
| 1 | Net Business Income Before Wages, etc. | 200,000 | 200,000 |
| 2 | less W-2 Wages, includes SEHI | 0 | 70,000 |
| 3 | less Self-Employment Tax / Employer Payroll Taxes | 10,918 | 4,437 |
| 4 | less Self-Employed Health Insurance (SEHI) | 12,000 | 0 |
| 5 | less Employer 401k / SEP IRA | 37,087 | 17,500 |
| 6 | Section 199A Qualified Business Income | 151,995 | 108,063 |
| Adjustments to Adjusted Gross Income / Net Biz Income | |||
| 7 | less Social Security Tax | 8,240 | 0 |
| 8 | less Medicare Tax | 2,678 | 0 |
| 9 | less SEHI, 401k | 49,087 | 31,000 |
| 10 | Other Taxable Income | 0 | 0 |
| 11 | Adjusted Gross Income | 139,995 | 147,063 |
| 12 | Itemized / Std Deductions | 24,000 | 24,000 |
| 13 | Taxable Income Before Section 199A | 115,995 | 123,063 |
| 14 | Section 199A Net Biz Income | 30,399 | 21,613 |
| 15 | Section 199A W-2 Wage Limit | 0 | 35,000 |
| 16 | Section 199A Taxable Income Limit | 23,199 | 24,613 |
| 17 | Section 199A Benefit (lower of ln 14, 15, 16) | 23,199 | 21,613 |
| 18 | Marginal Income Tax Rate | 22% | 22% |
| 19 | Income Tax Benefit from Section 199A | -5,104 | -4,755 |
| 20 | plus Self-Employment Tax | 21,836 | 0 |
| 21 | plus Tax on Line 12 Delta (above) | 0 | 1,555 |
| 22 | plus Payroll Tax (Employee and Employer) | 0 | 8,874 |
| 23 | Net Tax After Section 199A Benefit | 16,732 | 5,674 |
| 24 | S Corp Benefit SE Tax Reduction Only | 12,962 | |
| 25 | S Corp Benefit Section 199A Only | -1,904 | |
| 26 | Net S Corp Benefit $ | 11,058 |
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