Important Information For S Corporations
July 1, 2013
Dear Valued Clients,
We are posting another letter that we thought would be informative to many of you with regard to the taxation of certain fringe benefits paid by S Corporations for their shareholder-employees. While this information may not be applicable to all of our clients, we still think that it is important to share the information with you in case this situation might be applicable to you in the future.
Fringe Benefits to 2%-Shareholder Employees of S-corporations
Tax law generally allows employers to deduct the cost of fringe benefits, while also allowing employees to exclude the benefit amounts from their gross income. However, in applying these income tax rules relating to employee fringe benefits, an S corporation is treated as a partnership, and any person who is a more-than-2% shareholder is treated in the same manner as a partner of a partnership.
This means 2% shareholders (and their families) are considered owners rather than employees and can’t participate in cafeteria plans. This also means that certain fringe benefits are treated as compensation to the 2%-shareholder employees. While the corporation may deduct these expenses as compensation, the employee must include them in income, and may then claim a deduction for the taxable item on their individual tax return.
Failure to comply with taxable fringe benefit reporting could result in adverse tax consequences for the S corporation and its shareholders in an audit. We recommend that, no later than the beginning of December each year, S-corporations inform their payroll providers of the amount and classification of taxable fringe benefits.
Although there are many fringe benefits to consider, the most common benefits we come across are amounts paid by an employer to an accident and health plan and contributions by an employer to an HSA (health savings account). These fringe benefits are subject to income tax but are not subject to FICA and FUTA.
Deducting the Benefits
A 2%-shareholder employee is eligible to deduct the HSA contributions in arriving at the adjusted gross income.
The amounts paid during the year for medical care premiums may also be deducted if the medical care coverage is established by the S corporation and the shareholder meets other self-employed medical insurance deduction requirements. If, however, the shareholder or the shareholder’s spouse is eligible to participate in any subsidized health care plan, the shareholder is not entitled to the AGI deduction.
A medical plan can be considered established by the S corporation if the S corporation paid or reimbursed the shareholder-employee for premiums and reported the premium payment or the reimbursement as wages on the shareholder-employee’s W-2.
Health Insurance Purchased in Name of Shareholder
The IRS has ruled that if the shareholder purchases the health insurance in his own name and paid for it with his own funds, the shareholder would not be allowed an above-the-line deduction.
On the other hand, if the shareholder purchased the health insurance in his own name but the S corporation either directly paid for the health insurance or reimbursed the shareholder for the health insurance and also included the premium payment in the shareholder’s W-2, the shareholder would be allowed an above-the-line deduction. Therefore, in order for a shareholder to claim an above-the-line deduction, the health insurance premiums must be paid by the S corporation and be included in the shareholder’s W-2.
There are many other fringe benefits provided by the S Corporation for their owner-employees that might require taxable wage adjustment at the end of the year. Among these benefits would include employer-provided transportation, expense allowances, and education expenses. We will address these fringe benefits in a future newsletter. However, we are happy to discuss any questions that you might have regarding them now. Please do not hesitate to call us to discuss your questions or concerns.
Very truly yours,
Scott B. Price & Company