Self-employed can deduct Medicare premiums, IRS Chief Counsel advises

Explaining a recent reversal of a long-held IRS stance, the Office of Chief Counsel advised IRS attorneys that self-employed individuals may deduct Medicare premiums from their self-employment income. Chief Counsel Advice (CCA) 201228037 clarifies an IRS position that previously has appeared only in instructions to Form 1040, U.S. Individual Income Tax Return, and IRS publications for tax years 2010 and forward allowing the deduction.

Taxpayers who failed to deduct Medicare premiums for prior tax years within the statute of limitation period may file amended returns to claim the deduction.

Before tax year 2010, Form 1040 instructions for line 29 stated, “Medicare premiums cannot be used to figure the [self-employed health insurance] deduction.” Before 2010, Publication 535, Business Expenses, stated that Medicare Part B premiums were not deductible as a business expense, in keeping with Field Service Advisory (FSA) 3042, issued in 1995.

For the 2010 Form 1040, the instructions for line 29 were changed to specify that “Medicare Part B premiums can be used to figure the deduction.” The 2010 version of Publication 535 was similarly amended, but the IRS offered no guidance or explanation for the change.

Sec. 162(l)(2)(A) limits the deductible amount of payments made for health insurance to the taxpayer’s earnings from the trade or business “with respect to which the plan providing the medical care coverage is established.” FSA 3042 stated that this meant that payments under a plan that is not established with respect to the taxpayer’s trade or business (specifically including Medicare Part B, because it is a federal program) are not deductible.

The CCA, however, states that because Medicare is insurance that constitutes medical care under Sec. 162(l), it is similar to other health insurance and its premiums can similarly be deducted, including for coverage of a self-employed taxpayer’s spouse and qualifying child or other dependent. Children can include those up to age 27 (effective March 30, 2010).

The CCA states that premiums for all Medicare parts are deductible.

Besides a sole proprietor, a self-employed individual for purposes of the deduction can be a partner or S corporation employee who is a more-than-2% shareholder on whose behalf the partnership or S corporation pays the premium. Or the partner or S corporation employee-shareholder may pay the premium directly and be reimbursed by the partnership or S corporation. In either case, the amount must be properly reported and included in the partner’s or employee-shareholder’s gross income.