S-Corporation Employee-Shareholders: Be Careful With Medical Premiums

Creating an S-corporation for your small business can have many tax advantages. As a result, this type of entity is a popular choice among business owners. S-corp owners must be careful, however, to avoid some of the potential tax problems. A key issue that can arise is whether funds provided to an employee, who is also a shareholder, is taxable compensation or a shareholder distribution. S-corporations are required to pay reasonable compensation to shareholder-employees who provide services. As with any other type of employee, appropriate payroll taxes must be withheld and paid. Failing to do so can result in a tax problem with the Internal Revenue Service (IRS).

S-Corporations, Compensation, and Medical Premiums

Attempting to get around the self-employment tax issue is not a wise idea, as it can subject you to penalties and fines if you do not withhold and pay taxes properly. It is also important to recognize that health and accident insurance premiums paid on behalf of a shareholder-employee who owns at least two percent of the shares in the company are also a form of compensation—they must be reported as wages for income tax withholding purposes. One exception to note is that medical insurance premiums are not subject to withholdings for Social Security, Medicare, or unemployment taxes.

If you are unsure as to whether your S-corporation may face potential IRS problems with regard to medical insurance premiums and employment taxes, consider the following:

  1. Did the S-corporation pay or reimburse the shareholder-employee for premiums?
  2. Did the S-corporation report the premium payment?
  3. Did the S-corporation report the reimbursement as wages on the shareholder-employee’s W-2?


We understand that these tax issues are complex, and we are here to provide guidance to help you resolve tax problems that arise. Even though tax problems should be avoided at all costs, it is not the end of the world (or your business) if you find yourself in a situation with the IRS. We encourage you to learn more by reading our free guide, The Ultimate Survival Guide for IRS Problems.

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