HSA contributions for employees are usually deductible expenses for most businesses. However, HSA contributions made on behalf of Small Business Owners are subject to different rules. Sole proprietors, Partners and 2% shareholders of an S corporation are not eligible for salary reduction (Pre-tax) contributions to an HSA. The owners can establish HSAs and fund their HSAs in anyway they see fit. They can then deduct their HSA contributions on their individual tax return.
Sole proprietors
Sole proprietors can deduct the amount contributed on behalf of employees on their schedule C. They are not allowed to deduct their HSA contribution as a business expense so it is not taken as a deduction on Schedule C; nor is it taken into account in determining net earnings for self-employment tax on schedule SE. Sole proprietors are treated as individuals making HSA contribution on their own. They can deduct it as adjustment on personal return.
Partnerships and LLCs
Employer contributions to the HSA of a bona fide partner are treated as distributions or guaranteed payments as determined by the facts and circumstances.
Contributions on behalf of partners by the partnership are treated as distributions to the partners (under §731), they are not deductible by the partnership and do not affect the distributive shares of partnership income and deductions. The contributions are reported as distributions of money on Schedule K-1, box 19 with code “A” and the partner can then take a deduction for the HSA contribution on their personal income tax return. Contributions made pursuant to a Section 125 plan will be added back to the owners as a taxable fringe benefit negating any tax benefit they might have otherwise received from a Section 125 plans.
There is an exception for guaranteed payments to partners. If the partner is entitled to a Guaranteed Payment from the partnership, then a special rule applies. The HSA contributions are still not treated the same as contributions to other employees. These contributions are deductible by the partnership (under IRC §162) and are includable in the partner’s gross income. The contribution is also reported as a Guaranteed Payment on the K-1. The partner can then deduct the HSA contribution on his or her personal income tax return.
S-corporations
When an S Corp makes a payment to an HSA account on behalf of its employees, the corporation’s HSA contribution is a tax-free fringe benefit to the employee that is reported on the employee’s Form W-2 in box 12, using the code “W.” While the employee receives a tax free fringe benefit, the S Corp deducts the contributions to the HSA as an employee benefit program expense. This rule does not apply to the owners of the S corporation. Anyone that owns more than 2% of an S-corporation is regarded as an owner of the corporation with regards to HSA contributions. The rules above under partnership apply to employer HSA contributions to 2%-shareholders of an S-corporation. They can not make pre-tax contributions to their HSA via a salary reduction. Contributions by an S corporation to a 2% shareholder-employee’s HSA for services rendered are treated as guaranteed payments. The corporation can deduct them as officer compensation wages. They are included in the shareholder-employee’s gross income for income tax withholding purpose on W-2, but are not wages subject to social security taxes and Medicare tax if the requirements for exclusion under section 3121(a)(2)(B) are satisfied. So they are not included in box 3 and 5 on W-2 but are included in box 14 identified as 2%HSA. They are included in box 2 (wages) but not in box 5a (social security) and 4c (Medicare wages) on Form 941. They are included in box 3 (total payment to all employees) and box 4 (payments exempt from FUTA tax) on Form 940. The shareholder-employee can deduct the contribution made to the shareholder-employee’s HSA as adjustment on personal return.
