As of February 2022, nearly 11% of the total U.S. workforce was self-employed. While obtaining health insurance was once a major challenge for self-employed individuals, the introduction of the Affordable Care Act (ACA) in 2014 created a critical shift. Approximately 30% of self-employed individuals were uninsured in 2013, and this number dropped to 20.5% in 2019 — a net change of around 1.3 million fewer uninsured self-employed adults.
There are many benefits that come with being self-employed, including flexible scheduling, creative control, and the ability to receive a tax deduction for your health insurance premiums. While this exclusive tax benefit is typically not the only reason people choose to work for themselves, its impact can be significant. Discover how the self-employed health insurance deduction works, eligibility requirements, and special tax rules to keep in mind.
What Is the Self Employment Tax Deduction?
The self-employment health insurance deduction allows eligible self-employed individuals to deduct the cost of monthly health insurance premiums from their taxable income. This applies to premiums paid for medical, dental, and qualified long-term care insurance coverage for the self-employed individual, their spouse, dependents, and non-dependent children under the age of 27.
A tax deduction reduces your taxable income, which in turn lowers your overall tax bill. This particular deduction is an above-the-line deduction, meaning that you do not need to itemize your deductions to receive the benefit. Since 2003, the self-employed insurance deduction has allowed for a deduction of up to 100% of eligible premiums paid. For example, if you spent $7,600 on health insurance premiums during the tax year, you may be able to reduce your taxable income by $7,600.
Are You Eligible for the Self-Employed Health Insurance Deduction?
The IRS considers you to be self-employed if you own a business that takes in income and does not have any employees. This includes individuals who work as business owners, sole proprietors, independent contractors, freelancers, gig workers, and consultants. You may also be considered self-employed if you work for yourself in any other way, even if it’s only part-time.
Specifically, IRS guidelines state that you are self-employed if you:
- Carry on a trade or operate a business as an independent contractor or sole proprietor
- Are a member of a partnership that carries on a trade or business
- Are otherwise in business for yourself, including gig workers and part-time businesses
In addition to self-employed taxpayers who file a Schedule C, the deduction can also be claimed by individuals who are:
- More than a 2% owner in an S-corporation and received wages from the corporation
- Members of a partnership or an LLC that files Form 1065
What Can Make You Ineligible for the Tax Deduction?
Being categorized as self-employed does not mean you are automatically eligible for the self-employed health insurance deduction. If you also have a W-2 job that offers health insurance or you’re eligible for coverage under your spouse’s employer-sponsored plan, you are ineligible to take the deduction. This is true even if you choose not to purchase health insurance through the available plan.
Since this deduction is calculated on a monthly basis, it may be possible to take a deduction for part of the year. For example, suppose you were a freelancer who also worked a W-2 job that provided access to an employer-sponsored health insurance plan from January through May. You can use the deduction for June through December when you no longer had access to the employer-sponsored health plan. The premiums you paid for your insurance during January through May would be excluded from the total amount of your deduction.
The tax deduction is also limited to the amount of net profit earned from the business. If you have a net loss or did not have any net income during the tax year, you cannot take the self-employment health insurance deduction for that year.
In addition, if your net income from the business is less than the total amount you paid for your insurance premiums, you may only take a deduction equal to your total net profit. For example, if your net business profit is $500 and you paid $1,200 for your health insurance premiums, you can only take a self-employed insurance deduction for $500. You can include the remaining $700 as an itemized deduction on your tax return. However, this amount is considered part of your itemized medical expenses and is subject to a limit of 7.5% of your Adjusted Gross Income.
How to Get the Self-Employment Tax Deduction
When you take the self-employment health care deduction, it’s applied to your personal income taxes rather than recorded as a company expense on your Schedule C or business tax return. To claim it, you need to complete Schedule 1 of the Form 1040 tax form. The IRS provides a Self-Employed Health Insurance Deduction Worksheet to help you determine how much of your premiums you can deduct. However, certain scenarios require the use of a different worksheet.
Refer to the worksheet in Publication 535 if any of the following criteria apply:
- You have multiple sources of taxable self-employment income
- You’re including premiums paid for qualified long-term care insurance
- You file Form 2555 to exclude foreign income from your tax return
Use the worksheet provided in Publication 974 if you meet either of the criteria below:
- Your business health insurance plan was purchased through the Health Insurance Marketplace
- You are eligible for premium tax credits for health coverage you purchased through the Marketplace
Once you’ve calculated the total amount of eligible premiums, enter this amount on Line 17 (adjustments to income) of your Schedule 1.
Self-Employed Individuals vs. Business Owners
While the terms self-employed and business owner are sometimes used interchangeably, they are different. Generally, if you work for yourself and do not have any employees, you are considered self-employed. This includes sole proprietors and partners without a separate legal entity for their business, as well as independent contractors who work for someone else but are not considered an employee.
Once you’ve hired someone to work for you, you’re considered a small business owner. This is true whether you hire employees or independent contractors. Setting up a separate entity, such as an LLC, an S-corporation, or a C-corporation, also categorizes you as a business owner. Business owners with employees have more to consider than self-employed individuals.
Business Owners: How to File Health Insurance Costs Paid for Your Employees
If you have employees working for you, you can typically deduct the following payments made on behalf of your employees:
- Medical and dental insurance premiums
- Qualifying long-term-care insurance premiums
- Health savings account (HSA) contributions
These deductions are itemized as business expenses rather than applied directly to your personal tax return. For example, if you are a sole proprietor, you could deduct them on your Schedule C – Profit and Loss from a Business form.
S Corporations: Special Tax Rules
For S-corporations, the tax rules are a bit different. If the S-corp pays health insurance premiums for shareholder-employees, the corporation can generally deduct this as a business expense. For all shareholder-employees who own more than 2% of the corporation, the cost of the health insurance benefits must also be included on the shareholder’s W-2 form.
When health insurance premiums are paid by an S-corp and reported as taxable compensation on a W-2, the shareholder-employee can also take a tax deduction on their personal income tax Form 1040.