LEGISLATION

The Small Business Jobs & Credit Act of 2010 (H.R. 5297) signed into law by President Obama in September 2010 included a provision that would temporarily address the current inequity in the tax code faced by the self-employed regarding the deductibility of their health insurance costs.  Under the new law, the self-employed will be allowed to take a one-year tax deduction for health costs in determining payroll tax (self-employment tax.)  This deduction is available for health insurance costs paid by self-employed business owners in 2010. Self-employed business owners should look to take advantage of this deduction when preparing their taxes next year in time for the April 15, 2011 tax filing deadline. 

In the 111th Congress, the Equity for Our Nation’s Self-Employed Act (H.R. 1470/S. 725) has been introduced in both the House and Senate. Congressional leaders in the committees of jurisdiction have taken the lead on this important legislation. Rep. Ron Kind (D-WI) and Rep. Wally Herger (R-CA), members of the House Ways & Means Committee are championing the bill in the House. Senators Mary Landrieu (D-LA), Jeff Bingaman (D-NM) and Orrin Hatch (R-UT) of the Senate Finance Committee are heading the effort in the Senate.

These important bills would permanently address a significant tax inequity faced by our nations’ self-employed. Currently, the self-employed (sole-proprietors) are the only business entity not allowed a full deduction for health insurance. This bill would allow the self-employed to fully deduct their health insurance premiums for the purposes of their self-employment tax (FICA) creating a level playing field while also making health coverage more affordable for the over 22 million self-employed.


BACKGROUND

All employees who receive compensation from employers pay FICA taxes. FICA comprises Social Security (6.2 percent) and Medicare (1.45 percent) taxes. Employers are required to withhold from gross compensation 7.65 percent for FICA. In addition to the FICA withheld from the employee, the employer is required to “match” the FICA withholding. Therefore, the employee and employer contribution for FICA is 15.3 percent of compensation (subject to applicable annual limits). The self-employed pay FICA at a rate equivalent to employees and employers, 15.3 percent. FICA tax for the self-employed is called “self-employment tax.”

All business entities other than sole-proprietors receive a deduction for health insurance premiums as an ordinary and necessary business expense for all employees including owners. Employees and the owner pay for their health insurance premiums pre-tax therefore they are not subject to FICA taxes. However, sole-proprietors (Schedule C filers) do not receive this benefit. The premiums are not paid with pre-tax dollars and are exposed to self-employment tax. Again, sole proprietors are the only business entity that does not receive a full deduction of health care costs.

While 100 percent deductibility of health insurance premiums has phased in by Congress, it does not solve this tax inequity. One hundred percent deductibility relates only to income tax and not self-employment tax.

For example, health insurance premiums for Mr. Smith, a self-employed individual is $8,000 per year.

The tax detriment for the sole proprietor, Mr. Smith, is the annual insurance premiums multiplied by the-self employment tax rate (15.3%).

Amount X .153 = self-employment tax on that premium
$8,000 X .153 = $1,224
It can be seen from this calculation that Mr. Smith is paying an extra $1,224.00 in self-employment taxes on his health care each year. No other owner or employer in the U.S. pays this additional tax on his health coverage.

The health insurance premiums of the self-employed should not be subject to self-employment tax regardless of the entity form under which the business is operated.

The Equity for Our Nation’s Self-Employed Act would remove the section of the IRS code disallowing sole-proprietors a business deduction (Schedule C) for health insurance. If the bill passes, the code section would be removed and IRS would have to include on the Schedule C tax form a line item for a health insurance deduction.