Many business owners elect to use S Corporation status for tax filing purposes. While this seems like a straightforward choice for tax purposes, businesses often run into snags when it comes to deducting the owner’s benefit expenses.
Health Insurance – Deduct with Care
How, and where, to deduct the cost of this basic employee benefit for shareholders of S-corporations can be very confusing. Perhaps no issue has raised more debate and ire among business owners and their CPAs than the issue of health insurance deductibility for the shareholders of an S Corp.
Any S corporation shareholder who, during the tax year, owns at least 2% of the outstanding stock in the company is impacted. While there are avenues for S Corps to deduct health insurance premiums, the IRS has laid down several requirements that must be met before they can become 100% deductible. Even with that, there may be some unforeseen pitfalls that can cause some problems for S Corps.
Essentially, in order for the health insurance premiums for a 2% shareholder to be deductible, the premium costs must be reported as income to the shareholder on his/her W-2, which then makes it a deductible expense to the S Corp.
The shareholder reports it as income and then the deduction for the cost is passed through so that the premiums can be a deducted on shareholder’s 1040 income tax form. (If this seems needlessly complicated, it just means you are looking for logic where there is none.)
There are Pitfalls
Among the many caveats the IRS has placed on this deduction is the eligibility of the shareholder and his or her family members based on the availability of any other subsidized health plans. If a spouse works for another employer that provides subsidized health benefits, the premiums may not be deductible.
In addition, the premiums are only deductible to the extent that they don’t exceed the amount of income the shareholder derives from the company. For newer companies, where the income may be low in the beginning years, the cost of annual premiums may be more than what the shareholder is earning from the business. If the income is $8,000 and the premium is $10,000, then the deduction is allowed up to $8,000.
Another key requirement is that the premium payments must be made by the S Corp or, if paid by the shareholder, there must be some evidence of the payment which is then reimbursed by the company.
Bottom line, it is important to discuss how to handle this with your accountant. If you’re preparing your returns using tax preparation software, make sure you follow the instructions around this carefully. And, be sure to understand how to report the income on shareholder W-2s as well.
Retirement Plan Deductions More Clear Cut
An S Corp that establishes a qualified retirement plan for its employees, such as SEP plan or SIMPLE 401(k), and makes contributions to the employees’ accounts, may deduct the contribution on its corporate return. Deductions can also be taken for contributions made to 2% employee-shareholders who earn income from the business. As long as the company follows all of the reporting and disclosure rules for the plan selected, the deductions are fairly straightforward.
Other Employee Benefits
Often times a company will want to provide work related benefits such as continuing education for certain employees. The expenditures, if paid for by the company, are considered a deductible business expense, and generally not includable in the employee’s income. If the company provides a car to an employee for business use, it may be considered a deductible expense to the company and not taxable as income to the shareholder employee to the extent the car is used for business purposes. But documenting personal versus business use of a car is required to calculate the tax deduction and the value of the personal use of the car may need to be included on the employee’s W-2.
Because there are continuing court rulings and IRS clarifications being issued with regard to the tax treatment of S Corps, the guidance of a qualified tax accountant or attorney who specializes in S Corps may be advised.
Great for Taxes, Confusing for Shareholder Benefits
S corporation tax filing status is popular with small business owners because the business profits are taxed at the owner’s personal tax rates. S status is a tax status, not a type of corporation. To be taxed in this way, a business must file Form 2553 with the IRS and receive approval. This election is available for both Corporations and LLCs and increasingly is the preferred choice for small business owners.
For non-accountants, the rules it applies to deductions are complex at best. But benefits are significant expenses for small businesses, so it is important to understand the tax implications of S-Corporation filing status with respect to benefits.