SCorporation Shareholders and Fringe Benefits
S-corporations provide some positive tax treatment for their owners (flow-through treatment of income to avoid double taxation and potential for lower self-employment tax). However, at the same time there are other matters that require jumping through some hoops to avoid negative results. One of these is the treatment of fringe benefits for those S-corporation owners who are also employees of the corporation. Technically, the rules surrounding the treatment are only for those shareholders who own more than 2% of the S-corporation. So, if you actually own less than 2% of the corporation, none of the following will apply.
Employees may receive certain fringe benefits paid for by their employers, such as health insurance, without being taxed on the value of the benefit. S-corporation shareholder-employees are denied the tax-free privilege. Other common benefits with tax-free treatment that are denied are contributions to health savings accounts, group term life insurance coverage, and benefits from cafeteria plans. The shareholder may still receive the fringe benefit – it’s just that they must include the value in their income.
In regards to health insurance coverage, the corporation can still provide the benefit and make the premium payment. However, that amount will need to be added onto the shareholder-employee’s W2 as compensation. As such, it will be subject to income, FICA, and Medicare tax. This takes a little planning but can be handled rather easily. The major payroll services are aware of the requirement and can take care of getting those amounts reported correctly.
It is important to get that health insurance premium on the W2. The shareholder-employee may deduct the premium included in the W2 on their individual tax return as self-employed health insurance. This is an “above-the-line” deduction that is available to all taxpayers – even those who do not itemize their deductions. If the premium is not paid by the company, or it is but does not get onto the W2, it is not possible to take the deduction on the individual return.
Health Savings Accounts
Companies may make contributions to an employee’s health savings account as a tax-free fringe benefit. But again, an S-corporation shareholder does not qualify for this treatment. The contribution to a shareholder-employee will be treated similarly as the health insurance, with one exception. The payment will be added to the W2 but will NOT be subject to FICA and Medicare taxes, only income taxes. And then on the individual tax return, a deduction can be taken for contributions to the HSA in an amount equal to what is included on the W2.
In reality all of this is just moving things around. Like I said earlier, it is jumping through hoops. The benefits that are included on the W2 can be deducted on the individual return, so the deduction offsets the addition to the W2. The S-corporation is able to deduct the payments it made for health insurance and HSA contributions, so that deduction is passed through to the shareholder on the K1.
Greg Tanner – is a Tax Principal at Wertz & Company, LLP, a Professional Services Firm located in Orange County, CA that specializes in working with entrepreneurs along their journey to success.