Health insurance costs and volunteer work expenses

Tax Talk

When to file out-of-state returns and insurance concerns for small-business owners's tax experts answer your questions

Tax Talk

March 31, 2004|By Todd Beamon | Todd Beamon, Staff

Each Wednesday through April 21,'s tax experts will answer your questions this tax-filing season.

Our experts are Jim Dupree of the Maryland office of the Internal Revenue Service in Baltimore and, this week, Gregory S. Horning of Stout, Causey & Horning in Hunt Valley.

To be included next week, please use the form at the right side of this page to submit your questions.

My wife, my son and I live in Baltimore. My wife had a job in Baltimore; I worked in Newark, Del., all of last year. Do we need to pay both states' taxes? How would we go about filing?

Paul, Baltimore

Dupree: Paul, I have to refer you to Maryland and Delaware tax experts.

Horning: You will need to file returns and pay taxes in both Delaware and Maryland. You need not be taxed twice for the same income, but some extra steps will be required to ensure proper payment.

First, file your Delaware non-resident return using state Form 200-02. You will only be taxed on your Delaware wages for 2003. The Delaware withholding reported on your W-2 will be applied against your Delaware tax liability.

Then, file your Maryland resident return using state Form 502. Maryland taxes will be calculated on your total federal income, including all wages earned in Delaware and Maryland.

However, you also will need to file Form 502CR, Personal Income Tax Credits for Individuals, entitling you to a tax credit for the tax liability you incurred in Delaware. The maximum credit available to you will be calculated based on the state tax you would have paid in Maryland on your Delaware income.

Note that the credit will not offset any local "piggyback" taxes on your Maryland return; only your state tax liability will be reduced. You should note that since Delaware has a higher tax rate than Maryland, you may not be entitled to a credit of the full amount you paid there.

Effectively, after filing these returns, you will have paid state tax on your wages at the higher of the states' tax rates, Delaware in your case.

I am a small-business owner who has my health insurance through my wife's employer. She soon will be working for me, and we will need to purchase private health insurance. We understand that health insurance premiums will be tax deductible.

How would the premiums be deducted, from our income or from taxes owed? Also, is it better to purchase the health insurance through our business, a "C" corporation, or as private citizens?

Peter, Chester

Dupree: Currently, health insurance premiums, for those who are self employed, are 100 percent deductible. You may be able to deduct 100 percent of the amount paid for medical and dental insurance and for qualified long-term care insurance for you, your spouse and your dependents if you are one of the following:

A self-employed individual with a net profit reported on IRS Schedule C, C-EZ, or F.

A partner with net earnings from self-employment reported on line 15a of IRS Schedule K-1 (Form 1065).

A shareholder owning more than 2 percent of the outstanding stock of an "S" corporation with wages from the corporation reported on Form W-2.

The insurance plan, however, must be established under your business. You may be allowed this deduction whether you paid the premiums yourself or your partnership or "S" corporation paid them and you included the premium amounts in your gross income.

Take the deduction on line 29 of Form 1040. See page 25 of Publication 535, "Business Expenses," for more details on when and exactly how to deduct these premiums.

Horning: If the "C" corporation pays the premiums, the corporation will deduct the cost of the premiums. This will not affect your personal tax situation because the corporation is a separate legal entity and pays its own taxes.

If you elect to pay the premiums as a private citizen, the premiums can only be deducted to the extent that your total medical expenses exceed 7.5 percent of your adjusted gross income (this assumes you itemize your deductions rather than utilizing the standard deduction) because you are not considered to be self-employed.

There are very few people who actually receive any benefit on their individual returns for medical deductions.

Therefore, the answer to your question is that it would be better to purchase the insurance through the business so that the business receives a tax deduction and, presumably, pays less tax, leaving more money to distribute to shareholders.

For 2003 and thereafter, self-employed persons may deduct from gross income 100 percent of amounts paid during the year for health insurance for themselves, spouses and dependents.

It may, however, be beneficial to explore the possibility of converting to an "S" corporation. Among the numerous benefits to being taxed as an S corporation are the opportunity to deduct 100 percent of your health insurance premiums on your individual return, assuming that you are more than a 2 percent shareholder, because you would be considered to be self-employed.

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