A brief review of the tax rules on health insurance premiums may be useful. Health insurance premiums are deductible as itemized medical costs, but only to the extent your total medical expenses exceed 7.5% of adjusted gross income (AGI). If total medical expenses don't exceed 7.5% of AGI, no itemized deduction is available. (If you are subject to the alternative minimum tax, total medical expenses must exceed 10% of AGI.) However, a self-employed taxpayer in these circumstances can nevertheless deduct as a "nonitemized" deduction, reducing AGI—100% of the health insurance costs for him or herself, his or her spouse, dependents, and, after Mar. 30, 2010, any child of the self-employed who is under age 27 as of the end of the tax year.

Example. Max, a self-employed taxpayer, pays $3,000 in health insurance premiums and has no other medical expenses. His AGI is $50,000. Since 7.5% of $50,000 equals $3,750, Max isn't able to claim any itemized deduction for his medical expenses (the health insurance premiums). However, since he is self-employed, he can deduct the entire $3,000.

These rules only apply for any calendar month in which you aren't otherwise eligible to participate in any subsidized health plan maintained by any employer of yours or of your spouse, or, after Mar. 30, 2010, any plan maintained by any employer of your dependent or your under-age-27 child.

Also, no deduction is allowed to the extent that the deduction exceeds your earned income from the trade or business with respect to which the plan providing the medical care coverage was established.

These rules also apply to partners in partnerships and more-than-2% shareholders of S corporations where the partnership or corporation pays for health insurance coverage for its partners or shareholders.

And, for tax years beginning in 2010 only, the deduction also applies in calculating earned income from self-employment for purposes of self-employment tax. But that the benefit of that deduction is a little less straight forward.

Example. Assume that for 2010 Max paid $13,770 for health insurance coverage for himself, his spouse, his 13-year-old son, and his 11-year-old daughter. Max can deduct that $13,770 in computing his net earnings from self-employment.

The 15.3% self-employment tax rate applied to the $13,770 of premiums is $2,107. But Max's actual tax saving will be less. If Max's net earnings from self-employment are at least $120,570 (the $106,800 old-age, survivors, and disability insurance (OASDI) tax income ceiling plus the $13,770 deduction), there will be no reduction in Max's 12.4% OASDI tax. Only Max's 2.9% hospital insurance (HI) tax, which has no ceiling, will be reduced.

In addition, an above-the-line income tax deduction is allowed for one-half of self-employment tax. So, any reduction in Max's self-employment tax as a result of the self-employment tax deduction for the health insurance costs will cause an increase in Max's income tax.

As I mentioned above, the above described tax benefits for self-employeds deduction of health insurance costs effectively mean your cost of health insurance is reduced. You may wish to consider stepping up to improved coverage in light of these savings. Please call if you wish to discuss how these rules apply to your particular situation or if you have any questions.