Are COBRA Premiums a Self-Employed Tax Deduction?

Are COBRA Premiums Tax Deductible? A Guide for Self-Employed Taxpayers

COBRA can provide valuable continuity of health insurance after you leave a job, but that coverage can come at a significant cost. If you become self-employed while continuing coverage through COBRA, you may naturally wonder: Are COBRA premiums tax deductible?

The answer requires some care. COBRA premiums can generally be treated as medical insurance premiums for purposes of the medical expense deduction when the applicable requirements are met. However, whether COBRA premiums qualify for the separate self-employed health insurance deduction under Internal Revenue Code Section 162(l) is less clear.

The IRS allows certain self-employed taxpayers to deduct health insurance premiums using Form 7206, Self-Employed Health Insurance Deduction. But the insurance plan must be established, or considered established, under the taxpayer's trade or business. Although IRS instructions provide rules for determining when this requirement is met, they do not specifically state whether COBRA coverage originating with a former employer qualifies.

That distinction is important. Self-employed taxpayers should not assume that COBRA premiums automatically qualify for Form 7206 simply because they became self-employed and now pay the premiums themselves.

Key Takeaways

• COBRA premiums are not expressly identified by the IRS as qualifying for the self-employed health insurance deduction.
• To claim the deduction under Section 162(l), the health insurance plan must be established, or considered established, under the taxpayer's trade or business.
• For a Schedule C or Schedule F taxpayer, IRS instructions state that a qualifying policy may be in either the name of the business or the individual. However, the instructions do not specifically explain how this rule applies to COBRA coverage inherited from a former employer.
• Because COBRA originates from an employer-sponsored health plan, tax professionals may differ on whether personally continued COBRA coverage satisfies the "established under the business" requirement.
• Partners and more-than-2% S corporation shareholders must comply with additional payment, reimbursement, and income-reporting rules for a health plan to be considered established under the business.
• If COBRA premiums do not qualify for the self-employed health insurance deduction, they may still potentially be included as medical insurance expenses on Schedule A, subject to the applicable rules and the 7.5% of adjusted gross income threshold.

What Is COBRA Health Insurance?

COBRA refers to continuation coverage available under the Consolidated Omnibus Budget Reconciliation Act. In many cases, COBRA allows employees and their families to temporarily continue employer-sponsored group health coverage after certain qualifying events, such as termination of employment or a reduction in working hours.

The major difference is cost. While an employer may have paid a substantial portion of the health insurance premium while you were employed, a person electing COBRA coverage can generally be required to pay the full cost of the coverage plus an administrative charge.

For someone leaving a traditional W-2 job to start a business, freelance, consult, or otherwise become self-employed, COBRA can therefore provide continuity of coverage while the new business is getting established.

The tax question, however, is separate from the health insurance question.

Are COBRA Premiums Tax Deductible for the Self-Employed?

Possibly, but the IRS has not provided clear COBRA-specific guidance allowing the deduction in every case.

Internal Revenue Code Section 162(l) provides an above-the-line deduction for qualifying health insurance costs of eligible self-employed individuals. The deduction can potentially cover insurance for the taxpayer, the taxpayer's spouse, dependents, and certain children under age 27.

One of the central requirements is that the insurance plan be established under the taxpayer's trade or business.

The IRS Instructions for Form 7206 explain that, for a self-employed taxpayer filing Schedule C or Schedule F, a policy can be either in the name of the business or in the name of the individual.

This individual-name rule is important and may support an argument for deducting certain personally held health insurance policies. It also demonstrates that a sole proprietor does not necessarily need to have a policy formally issued in a business name.

However, COBRA presents an additional question: the coverage originated under a former employer's group health plan. Continuing that coverage and personally paying the premiums after becoming self-employed does not necessarily establish that the plan is now "established under" the new trade or business.

Current IRS instructions do not specifically resolve this issue for COBRA coverage.

Why Tax Professionals May Disagree About COBRA

There are two competing considerations that help explain why taxpayers can receive different answers from tax professionals.

One view is that COBRA may qualify in appropriate circumstances. The Form 7206 instructions allow a Schedule C or Schedule F health insurance policy to be in the individual's name rather than the business's name. A taxpayer who becomes a sole proprietor, pays COBRA premiums personally, earns sufficient income from the business, and meets the other requirements may therefore have an argument that the coverage can be associated with the self-employed business.

The more conservative view focuses on how the plan was established. COBRA is a continuation of an employer-sponsored health plan that was originally established by a former employer. Because Section 162(l) ties the deduction to a trade or business under which the insurance plan is established, some tax professionals conclude that continuing a former employer's plan does not satisfy this requirement merely because the taxpayer subsequently becomes self-employed.

The IRS instructions do not expressly say that either interpretation applies to COBRA.

For that reason, we do not believe taxpayers should treat all COBRA premiums as automatically deductible on Form 7206.

What Does "Established Under Your Business" Mean?

The IRS provides different rules depending on how the taxpayer conducts the business.

Sole Proprietors and Schedule F Taxpayers

For self-employed individuals filing Schedule C or Schedule F, IRS Form 7206 instructions state that a health insurance policy can be either:

• In the name of the business; or
• In the name of the individual.

This is relatively flexible compared with the rules applicable to partnerships and S corporations. Nevertheless, the IRS continues to state that the plan must be established, or considered established, under the business.

The fact that the policy is in the individual's name therefore does not, by itself, answer every question concerning COBRA. A taxpayer considering the deduction should discuss the specific circumstances with a qualified tax professional.

Partners

A partner may also qualify for the self-employed health insurance deduction, but additional requirements apply.

According to the IRS, a policy may be in the partnership's name or the partner's name. If a partner pays premiums on a personally held policy, the partnership generally must reimburse the partner and report the premium amount as a guaranteed payment on Schedule K-1 for the plan to be considered established under the partnership.

If those steps are not followed, the IRS instructions state that the insurance plan will not be considered established under the business.

More-Than-2% S Corporation Shareholders

Special rules also apply to a shareholder who owns more than 2% of an S corporation.

Generally, the S corporation must pay or reimburse the health insurance premiums, and the premiums must be properly included as wages on the shareholder-employee's Form W-2. The IRS has stated that when a shareholder purchases insurance personally and the S corporation neither pays nor reimburses the premiums, the plan is not considered established by the S corporation for purposes of the Section 162(l) deduction.

See the IRS guidance on S corporation compensation and medical insurance for additional information.

Other Requirements for the Self-Employed Health Insurance Deduction

Even when a health plan satisfies the "established under the business" requirement, several additional limitations can affect the deduction.

1. You Must Have Earned Income From the Business

The self-employed health insurance deduction is generally limited by the earned income from the trade or business under which the insurance plan is established.

You cannot create or increase a business loss simply by deducting health insurance premiums under Section 162(l).

2. Eligibility for Employer-Subsidized Coverage Can Disqualify You

The deduction is generally not available for any month in which you were eligible to participate in a subsidized health plan maintained by your employer or your spouse's employer.

Importantly, the rule concerns eligibility. A taxpayer generally cannot preserve the self-employed health insurance deduction simply by declining employer-subsidized coverage and choosing another health insurance plan instead.

3. Only Eligible Premium Amounts Can Be Used

The deduction generally applies to amounts actually paid for qualifying health insurance coverage, subject to the applicable statutory and IRS limitations.

Premiums reimbursed by another party or otherwise paid with tax-free funds generally require separate consideration and should not simply be added to Form 7206.

How Form 7206 Applies to COBRA Premiums

Form 7206, Self-Employed Health Insurance Deduction, is used to calculate the amount of the self-employed health insurance deduction a taxpayer may be entitled to report on Schedule 1 of Form 1040.

Form 7206 does not contain a special line identifying COBRA premiums, and its instructions do not specifically state that COBRA continuation premiums automatically qualify.

Accordingly, taxpayers should first determine whether their COBRA coverage satisfies the Section 162(l) requirements—including the requirement that the insurance plan be established or considered established under the relevant trade or business—before including the premiums in the Form 7206 calculation.

If there is uncertainty, the appropriate treatment should be determined with a tax professional familiar with the taxpayer's particular business structure and insurance arrangement.

Example: Sole Proprietor Paying COBRA Premiums

Assume Laura leaves her W-2 job in March and elects COBRA continuation coverage. She begins operating a profitable freelance graphic design business reported on Schedule C and personally pays $800 per month for COBRA coverage.

Laura is clearly paying health insurance premiums and is now self-employed. However, those facts alone do not conclusively establish that her former employer's COBRA plan is a plan established under her freelance business.

The Form 7206 instructions provide some support for a possible deduction because a Schedule C taxpayer's policy can be in the taxpayer's individual name. On the other hand, Laura's COBRA coverage originated under her former employer's group health plan, and the IRS has not expressly stated that such continuation coverage satisfies the "established under the business" requirement.

Laura should therefore not automatically assume that all of her COBRA premiums belong on Form 7206. She should evaluate the position with her tax professional based on Section 162(l), the Form 7206 instructions, and her particular circumstances.

Example: Becoming Eligible for a Spouse's Employer Plan

Assume James is self-employed and maintains health insurance while operating his contracting business. In July, he becomes eligible to participate in a subsidized health insurance plan maintained by his spouse's employer.

Even if James chooses not to enroll in his spouse's plan, his eligibility for subsidized employer coverage can prevent him from claiming the self-employed health insurance deduction for the affected months.

If James was paying COBRA premiums before July, the separate question of whether that COBRA plan satisfies the "established under the business" requirement would still need to be addressed for the earlier months.

Can You Deduct COBRA Premiums on Schedule A?

If COBRA premiums do not qualify for the self-employed health insurance deduction, that does not necessarily mean they have no tax value.

Health insurance premiums paid with after-tax dollars can generally be included among qualifying medical expenses when determining the medical and dental expense deduction on Schedule A (Form 1040), provided the applicable requirements are satisfied.

However, the Schedule A medical expense deduction is subject to an important limitation: only the portion of qualifying medical and dental expenses exceeding 7.5% of adjusted gross income (AGI) is deductible.

You must also itemize deductions rather than take the standard deduction for the Schedule A deduction to provide a federal income tax benefit.

For additional information, see IRS Publication 502, Medical and Dental Expenses.

Self-Employed Deduction vs. Schedule A Deduction

What Records Should You Keep for COBRA Premiums?

If you are self-employed and paying COBRA premiums, maintain complete records regardless of which deduction ultimately applies.

Useful documentation can include:

• COBRA election notices;
• Monthly premium statements;
• Bank statements, canceled checks, or other proof of payment;
• Documents showing the dates your former employer coverage ended and COBRA coverage began;
• Records concerning eligibility for health coverage through your own or your spouse's employer;
• Business income records supporting your self-employment income; and
• For partnerships or S corporations, reimbursement and tax-reporting records required under the applicable IRS rules.

Good records can be particularly important when the tax treatment depends on the relationship between the insurance arrangement and the taxpayer's business.

Are COBRA Payments Tax Deductible? The Bottom Line

So, are COBRA payments tax deductible? They can potentially produce a tax deduction, but the method of deducting them matters.

For purposes of the self-employed health insurance deduction, taxpayers should be cautious about treating COBRA premiums as automatically deductible. Section 162(l) requires the insurance plan to be established under the taxpayer's trade or business, and current IRS guidance does not specifically state that continuation of a former employer's COBRA plan satisfies that requirement.

For Schedule C and Schedule F taxpayers, the IRS does allow a qualifying insurance policy to be in the individual's name. That provision may support a deduction in some circumstances, but it does not expressly resolve the COBRA question.

Partners and more-than-2% S corporation shareholders have additional requirements concerning how premiums are paid, reimbursed, and reported.

If COBRA premiums cannot be claimed under the self-employed health insurance deduction, the premiums may still potentially qualify as medical insurance expenses for Schedule A, subject to the itemization rules and the 7.5% of AGI threshold.

Because the IRS has not issued clear guidance specifically resolving the interaction between COBRA continuation coverage and the "established under the business" requirement, taxpayers considering the deduction should consult a qualified tax professional regarding their individual circumstances.

IRS Resources

• IRS Form 7206 – Self-Employed Health Insurance Deduction
• IRS Instructions for Form 7206
• IRS Publication 502 – Medical and Dental Expenses
• IRS – S Corporation Compensation and Medical Insurance Issues

This article is intended for general informational purposes only and is not individualized tax, legal, or accounting advice. Tax rules can change, and the treatment of a particular insurance arrangement depends on the taxpayer's specific facts and circumstances. Consult a qualified tax professional regarding your situation.