Tax Subsidies for Private Health Insurance

III. Special Tax Deduction for Health Insurance Premiums for the Self-Employed

People who are self-employed often look to the non-group market for health insurance. The Bureau of Labor Statistics estimates that one-in-nine workers, or 15.3 million people, were self-employed in 2009.¹ Starting in 2014, these households are able to access health care coverage and premium tax credits through the health insurance exchanges. In addition to premium tax credits, self-employed households can deduct the full cost of qualifying medical expenses.

Self-employed individuals are subject to federal income tax as well as self-employment tax, which is the equivalent to the FICA payroll taxes.² A special tax provision permits the self-employed to take a deduction when calculating their income tax for the amount paid for health insurance for themselves and their spouse or dependents.³ To qualify for the deduction, health insurance must be established under the self-employed person’s business. This deduction, however, has several limitations. First, the deduction may not be taken if the self-employed individual, or his/her spouse, was eligible for subsidized coverage offered by an employer. For example, if a self-employed individual was eligible for health benefits offered by the spouse’s company from January through March but the self-employed individual was paying premiums for an individual plan, those premiums would not be eligible for the deduction. A second limitation is that the amount deducted cannot exceed the net profit and other earned income from the business under which the health insurance plan is established. For example, a person with a small amount of self-employment income and additional income from other sources cannot deduct the full amount of his or her health insurance premiums if the premiums exceed the net profit of the business. A third limitation is that self-employment health insurance deductions reduce income for income tax purposes only, and may not be deducted when calculating the net earnings subject to the self-employment tax.

Self-employed households have the same income eligibility requirements for premium tax credits as households with wage income. Unlike individuals in the non-group market, self-employed households are able to deduct the full value of their qualified medical spending pending that their business generates sufficient net profit.

Figures 7 shows examples of the tax reductions for self-employed households enrolled in the second lowest-cost plan in San Francisco. The scenarios are the same as those assumed under Figure 4, except that the families deduct the full amount of their health insurance premium.⁴ The reduction amounts shown are calculated by computing each family’s taxes with and without a deduction for health insurance. The example households below $100,000 benefit from both the premium tax credit and the self-employed health insurance deduction. Similar to the dynamics for individuals in the non-group market, the tax deduction is regressive as it rewards wealthier families more; and the premium tax credit is progressive as it provides a higher subsidy for lower income households. The example households at or above $100,000 earn more than 400% of the federal poverty line and therefore pay the full premium cost ($11,563). Self-employed households at all income levels receive a higher tax subsidy than households with wage income, reflecting the fact that those that are self-employed can deduct the full amount of health insurance premiums, while people taking the medical expense deduction can only deduct expenses exceeding 10% of their adjusted gross income. Another interesting component of the tax burden faced by self-employed households is that they are unable to deduct health insurance spending from their self-employed tax liability. Because workers who receive an employer sponsored plan are not assessed FICA taxes on the value of their plan, employed-workers pay a smaller tax burden than similarly situated self-employed workers.