A major reason why small businesses choose to make an “S” election is that choosing to be an S corporation eliminates the double taxation that a regular (“C”) corporation is subject to. Limited liability companies (LLC) and partnerships have also been known to make the “S” election, since net income for an S corporation isn’t subject to self-employment tax, as a LLC or partnership would ordinarily be subject to. While there are definitely tax benefits to being an S corporation, some things are either not beneficial, or procedures need to be followed to get a benefit, and this is in the area of fringe benefits. The discussion below will pertain to “greater than 2-percent shareholders” of an S corporation, so if you’re the sole shareholder, or have a ‘partner’ who owns more than a two-percent interest, this applies to you.
Self Employed Health Insurance-if an S corporation pays premiums for health, dental, vision, hospital, accident (AD&D), or long-term care for a 2-percent shareholder, those premiums must be included in that person’s W-2, in order to be deductible. If they’re not included, there’s no deduction allowed at the entity level, and the individual can’t take a deduction for self-employed health insurance on page 1 of the Form 1040. The amount included in the W-2 is subject to federal and state tax withholding (but not Social Security/Medicare).
Cafeteria Plan-no, this has nothing to do with food, but this is food for thought. A 2-percent shareholder cannot participate in a cafeteria plan, and if she/he does, it’s not a cafeteria plan for any participating employee. If that’s the case, not even employees can make pretax contributions for any benefits within the plan.
Other items that must be included in a 2-percent shareholder’s W-2 include qualified transportation fringe benefits, qualified adoption assistance, employer contributions to medical savings accounts, qualified moving expense reimbursements, personal use of employer-provided property or services, and meals furnished for the convenience of the employer. Generally, these amounts aren’t taxable to employees, but when the employee is also a 2-percent shareholder, the game changes.
The key to this discussion is that if you’re a 2-percent shareholder of an S corporation, you need to consider what benefits are being paid by the corporation on your behalf, and have those amounts added to your W-2 before the end of the year. If you wait too long, you’ll lose the deduction, which means more tax money out of your pocket, and you don’t want that, do you?!
Please pass this article along to somebody you know, for whom it might be applicable. Leave a comment if you’ve had any experience with being a 2-percent S corporation shareholder and taking benefits.