I am an individual who is a 25% partner in a 4-member limited liability company (LLC) that is taxed as a partnership. This is my only income, and it is all from farming conducted by the LLC. I have my own health insurance and pay the premiums with my own after-tax dollars. I thought I could deduct the premiums on line 29 of my 1040, but am now told that the premiums must be run through the LLC and counted as guaranteed payment income to me from the LLC. This counters the benefits of the deduction, as I now show income that is higher than what I actually received, and my health insurance deduction on line 29 merely brings me down to what I actually made from the partnership. Is there any reason I can’t just claim the deduction on line 29 without having to run it through the partnership?
First, what you have been told about the treatment of health insurance to a partner in a partnership is correct. Based on Notice 2008-1 and IRS Publication 535, partners in a partnership (as well as more than 2% shareholders in an S corporation) are required to either have the entity directly pay their health insurance, or have the entity reimburse their health insurance, in order for the partner to claim the self-employed health insurance deduction. Thus, the advice you are receiving is accurate. However, your understanding of the economics of it needs clarification.
What you are missing is that the partnership is claiming a tax deduction for the health insurance/guaranteed payment. That reduces the overall farm net income, and accordingly your 25% share of the business income is reduced. Assuming that the other three partners also have their health insurance handled in this same manner, and assuming that all health insurance premiums are about of the same amount, it is all a wash compared to simply deducting the premiums individually.
However, there will be some economic distortion if there is significant disparity in the health insurance premium amounts per partner. For example, if you are young and single and have an annual health insurance premium of only $4,000 per year, and the other three partners are married with family policies that each have a premium of $12,000 per year, the partnership is reimbursing $40,000 of total partner health premiums ($4,000 plus 3 family premiums of $12,000 each). Your share of the partnership income has been reduced by 25% of the total premiums, or $10,000, even though your individual premium cost, if on your own, would have been $4,000. But effectively, the same result occurs in the corporate world, whether closely held or Fortune 500. The entity pays the premiums and deducts all as a business expense; the owners bear the cost according to ownership percentage, but individually may receive more or less benefit based on the type of individual or family coverage, age, etc. Over time, with single coverage changing to family coverage, and in later years with family coverage reducing to lower Medicare premiums, these differences can even out among owners of entities that survive many years.
There is another economic aspect of this as well, and that is the self-employed Social Security tax cost. The guaranteed payment income on the K-1 for the reimbursement of the individual health insurance is self-employment income and incurs either the 15.3% SE tax or, if overall income is greater, the 2.9% Medicare rate. But when you claim the offsetting deduction in your Form 1040 on page 1, you only reduce taxable income, not self-employment income. Thus, you will pay some extra Social Security tax on that reimbursed premium. S corporation shareholders, however, have a reporting mechanism through Form W-2 on the reimbursed premium that does not trigger any Social Security tax.
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May I move Agricultural Risk Coverage (ARC) payments made to me in 2015 to the tax year 2016?
Your suggestion of a one-year deferral is no doubt based on the special provision in Sec. 451(d) of the tax code, allowing cash-method farmers to defer the proceeds of crop insurance for one year. But that election requires that the deferral amount consists of insurance proceeds received as a result of destruction or damage to crops. The law also allows USDA Disaster Assistance received for natural disasters to be deferred. But unfortunately, ARC payments, as well as their predecessor deficiency subsidies, are not specifically disaster payments from weather-related casualties, and accordingly the ARC payments may not be electively deferred.
EDITOR’S NOTE: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years of experience in ag taxation, including 30 years as a trainer for the American Institute of CPAs and other technical seminars. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future tax columns, e-mail AskAndy@dtn.com.