How does the Cobra health insurance deduction work?
My friend was laid off last year. Her husband is self-employed. Can the Cobra medical insurance payments paid to her former employer last year be deducted against her husbands self-employment income (he has no other medical insurance), or is this deducted (on page one line 29) or must these expenses be included on schedule A? My CPA friend thinks it must be included on schedule A. Can anyone help them argue that this is deducted on schedule C or at least on page one?
The answer provided by other commentators is this is a "schedule A" deduction. That would generally be my answer but let’s review the law to see if there is any position for your friends wife to deduct COBRA payments on line 29 of Form 1040. Following is some background on this deduction.
First, COBRA is a group health plan that allows a qualified beneficiary to pay the full cost of continuation coverage, whether or not the plan is contributory for active employees. The typical cost of this plan is 102% of the applicable premium. The extra 2% is for the cost of administering continuation coverage. This is important as some COBRA plans are subsidized and would be treated differently for purposes of this analysis, and our goal here (if possible) is to deduct the Cobra insurance premiums on line 29 of your Form 1040. What makes this analysis more difficult is this policy was issued through the wife’s former employer and not in the husband’s or the husband's business. A better set of facts would be if the wife opened her own business after being laid off and paid these Cobra payments (assuming her business was profitable).
Let's add that your friend's husbands business is jointly owned and operated by both the husband and wife though the wife may or may not be directly compensated by the business and that she does not qualify for any employer-subsidized health coverage. Even if this business is solely owned by the husband it may be considered to be jointly owned under certain states that follow the community property rules.
The law for this deduction is located under 26 U.S. Code Section §162(I)(1)(A). It allows, under the trade or business expense rules, a deduction (in the case of a taxpayer who is an employee defined under Section 401(c) as someone who is self-employed) in an amount equal to the amount paid during the taxable year for insurance which constitutes medical care for the taxpayer, the taxpayer’s spouse, the taxpayer’s dependents, and any child (as defined in section 152(f)(1)) of the taxpayer who as of the end of the taxable year has not attained age 27.
The second part of this section under §162(I)(2)(A) limits the deduction to the amount of such deduction such that it may not exceed the taxpayer’s earned income (within the meaning of section 401 (c)) derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established.
Thus Sec. 162(l)(2)(A) has been read by the IRS, prior to 2012, to limit 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”. If this reading is correct, then the law requires that any policy must be established under the taxpayers trade or business.
Field Service Advisory (FSA) 3042, issued in 1995, supports this reading of Sec. 162(l)(2)(A) stating 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 as they are not established or owned by the taxpayers trade or business.
In 2012, the IRS reversed its position on FSA 3042. In Chief Counsel Advice (CCA) 201228037 it clarified that self-employed individuals may now deduct Medicare premiums from their self-employment income. This CCA 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 coverage of a self-employed taxpayer’s spouse and qualifying child or other dependent even though it is not established or owned with respect to the taxpayer’s trade or business. This CCA allows that if you fail to claim self-employed health insurance deductions for these Medicare premiums (explicitly stating that premiums for all four Medicare Parts (A, B, C, and D) qualify) that you may file amended returns (limited to the statute of limitations) to claim any tax refunds.
A 2005 CCA (200524001) allowed “a self-employed individual who was a sole proprietor to deduct medical care insurance costs of the sole proprietor and his or her family from the earned income of his or her trade or business when a health insurance policy purchased by the sole proprietor was issued in his or her individual name...”
What is interesting about the 2012 CCA is that Medicare is not a plan established by the business and yet the wife’s premiums are allowed to be deducted though her premiums are not issued in a plan under the individual sole proprietor (self-employed) or business's name. This 2012 CCA treats Medicare as a plan “considered to be established” by the business whether or not it is in the sole proprietors individual name for Medical premiums paid including those paid by his wife. Therefore could we argue that the wife’s COBRA payments should be treated similar to Medicare as insurance that constitutes medical care under Sec. 162(l)", and are therefore deductible as self-employed health insurance for purposes of this provision though the COBRA insurance is not in the sole proprietors or business’s name?
I agree that schedule A is one answer and this may be correct law. However it appears (if I am reading this CCA correctly) that you may have a position to deduct the COBRA expense on line 29 of Form 1040. The 2012 CCA appears to support a position that a plan is not necessarily required to be a plan "established by the business", but rather that it is “considered to be established” by the business by either the sole proprietor or his wife, using Medicare as an example of this approach. The 2012 CCA is a departure from the IRS's previous position on this issue. I would suggest further research before taking this position to determine if there is additional support including if necessary a review of the legislative history of this or any other relevant Code section.
Also though the Health Coverage Tax Credit (HCTC) is your best answer it is very difficult to qualify for this credit.
With respect to CCAs, they are prepared by the Chief Counsel's National Office in Washington, D.C. and most times contain extensive legal analysis with preparation involving research of statutes, regulations, revenue rulings, case law, etc. So much so that they are in many ways considered standard attorney opinions. And, though Section 6110(k)(3) denies precedential status for CCAs it is still unclear whether the nomenclature “precedent” in Section 6110(k)(3) connotes “controlling authority” only or encompasses “persuasive authority” for CCA that are thoroughly prepared. The Internal Revenue Manual instructs IRS personnel to refer to CCAs for guidance in negotiations and in formulating a district office position on an issue and they do provide penalty protection.
There is a brief discussion on this issue at http://www.jklasser.com/askjk/my-wife-was-laid-off-from-a-job-and-took-cobra-now-shes-become-an-ind..
Also, as I am not an attorney please contact an attorney for legal advice.
Your CPA is correct, cobra payments do not qualify for treatment as self employment health insurance deduction. As far as your schedule C question, there is no argument to substantiate the cobra payments as a business expense. Line 14 of Schedule C is where a sole proprietor would show contributions the business made on behalf of its employees to an employee benefit plan, like an employer sponsored health insurance plan. However, owners cannot deduct contributions made under this plan on behalf of themselves or their family members.
Schedule A, itemized deduction may not be their only or best option for deducting the cobra payments. Given the fact that your friend was laid off, the cobra payments may qualify for the Health Coverage Tax Credit (HCTC). Depending on the details of her lay off, unemployment benefits and other factors, some or all of the Cobra payments may qualify for the Health Coverage Tax Credit (HCTC) using form 8885. If she qualifies this could be a significant credit or dollar for dollar reduction in tax liability. This credit has very strict qualifications and specific documentation must be provided with the return in order to receive the credit. I have included an excerpt from the instructions for Form 8885 for tax year 2013 outlining the general eligibility requirements. I hope this is helpful.
"Who Can Take This Credit:
You can take this credit only if (a) you were an eligible trade adjustment assistance (TAA) recipient, alternative TAA (ATAA) recipient, reemployment TAA (RTAA) recipient, or Pension Benefit Guaranty Corporation (PBGC) pension payee in 2013; or you were the family member of a TAA, ATAA, or RTAA recipient or PBGC payee who passed away or with whom you finalized a divorce, (b) you cannot be claimed as a dependent on someone else’s 2013 tax return, and (c) you met all of the other conditions listed on line 1. If you cannot be claimed
as a dependent on someone else’s 2013 tax return, complete Form 8885, Part I, to see if you are eligible to take this credit." Excerpt from IRS Form 8885 (2013) Instructions.
Unless your friend is an employee of he husband you are likely stuck with Schedule A. If she works for her husband (even part time) they can set up a Medical Expense Reimbursement Plan. If done properly he would be able to deduct not only all of her medical expenses on schedule C, but his as well. I have done this for many clients over the years.
I agree with the CPA. The only health insurance you can deduct on a schedule C is the premiums paid for one's employees. The owner deducts the premiums paid by the business for a plan issued by the business as an adjustment to gross income on the 1040, Corba payments for the owner does not qualify for this treatment as the plan is not issued by the business. Therefore a deduction to schedule A, subject to the 10% of AGI limitation. is correct.
As a small businessman he needs to have either a HR105 plan in place or a 125 plan then he can deduct it from his business, if, his business is paying the premium. other wise it is just a schedule A.
If you are paying the COBRA premiums with out of pocket funds, you can deduct the premiums paid as an eligible medical expense on Schedule A as an itemized deduction. Only your total medical expenses greater then 10% of your AGI can be deducted if you are under the age of 65. If you are age 65 or older then the AGI limit is 7.5%. Your total itemized deductions must be greater then your standard deduction to have any tax benefit. I believe your CPA is correct.