How S Corporations Treated Life‑Insurance Premium Deductions in 2018

Quick Answer

In 2018 an S corporation could not deduct life‑insurance premiums it paid on a shareholder's life unless the shareholder owned less than 2% of the company. Premiums for >2% shareholders were added to the shareholder's W‑2 as taxable wages, and the corporation could not claim a deduction. For all other employees, premiums were fully deductible as a business expense.

Why the Rule Exists

The Internal Revenue Code treats life‑insurance premiums on key persons differently from ordinary employee benefits. The purpose is to prevent corporations from converting personal insurance costs into tax‑free compensation.

Key Definitions

S corporation: A corporation that elects pass‑through taxation under IRC §1363.

2% shareholder: Any shareholder who owns more than 2% of the corporation's stock, directly or indirectly.

Key‑person insurance: A policy that protects the business against the loss of a vital owner or executive.

2018 Tax Treatment Overview

The treatment hinges on two factors: who the insured person is and the shareholder ownership percentage.

1. Premiums for >2% Shareholders

• Added to the shareholder's Form W‑2, box 1 (wages) and box 12 (code "W" for employer‑provided health coverage).
• The corporation cannot deduct the premium expense on its Form 1120‑S.
• The shareholder reports the amount as ordinary income and pays regular income tax and payroll taxes.

2. Premiums for <2% Shareholders or Non‑shareholder Employees

• Deductible as a regular business expense on Form 1120‑S, line 12 (Other deductions).
• No taxable wages are reported to the employee.

Reporting Requirements

For >2% shareholders, the employer must:

• Include the premium amount on the employee's W‑2.
• File Form 941 (employment taxes) on the increased wage base.

For other employees, the premium is simply recorded as an expense; no special reporting is needed.

Impact on Shareholder Tax Returns

The added wages increase the shareholder's Adjusted Gross Income (AGI) and may affect:

• Phase‑outs for deductions and credits.
• Social Security and Medicare tax liabilities.

Common Misconceptions

"The S corp can deduct the premium and the shareholder gets a tax‑free benefit." – Incorrect. The IRS specifically disallows this for >2% shareholders.

"Only the premium amount is taxable to the shareholder." – Correct for the wage inclusion, but the shareholder may also have to pay self‑employment tax on the S‑corp pass‑through income.

Practical Steps for 2018

1. Identify each insured individual and their ownership percentage.2. Separate premiums into two groups: >2% shareholders vs. others.3. Report >2% shareholder premiums on W‑2s and do not claim a deduction.4. Deduct other premiums on Form 1120‑S.5. Keep documentation (policy statements, premium invoices, shareholder ledgers) for audit protection.

Comparison Table: 2018 vs. Post‑2019 Changes

When to Seek Professional Advice

If your S corporation has multiple shareholders near the 2% threshold, or if you're using life‑insurance policies as part of a succession plan, consult a CPA or tax attorney to ensure correct classification and reporting.

Bottom Line

For the 2018 tax year, S corporations could deduct life‑insurance premiums only when the insured was not a >2% shareholder. Premiums for >2% shareholders became taxable wages, eliminating any deduction for the corporation. Proper classification and reporting are essential to avoid penalties and ensure compliance.