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The S-corporation can deduct the more than 2% shareholder's health insurance premiums for the shareholder and his/her spouse and dependents. However, the shareholder's wages from the S-corporation are treated as his/her "earned income", and no deduction is allowed in excess of the earned income as defined by code section 401(c). Also see section 162(l)(1) and (5) as well as IRS NOTICE 2008-1, and section 1372(b). Congress did this to prevent, or discourage, S-corporation owners from treating their earnings as dividends in order to avoid the employment taxes.
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