2% Shareholder Employees of S Corporations: Taxable and Nontaxable Fringe Benefits
government contractor and technology
audits, reviews and compilations; business advisory
By: Kristen Soles
The IRS code section related to fringe benefits in most cases allows employers to deduct the cost of fringe benefits, while employees may exclude those amounts from their gross income. Employer paid health insurance costs are an example of such costs. The IRS code looks at ownership percentages of S Corporation shareholders (similar to the treatment of partners in a partnership) for the treatment of certain fringe benefits. Shareholders, payroll personnel and HR departments of S Corporations may not be reporting taxable fringe benefits correctly on the W2 of shareholders. Following is a summary so you can make sure your taxable fringe benefits are reported correctly if you’re affected.
- Any S Corporation shareholder owning more than 2% of the stock on any day during the tax year.
- Any member of a shareholder’s family identified in number one above regardless if they actually hold stock in the S Corporation. (Spouse, child, grandchild, or parent)
What fringe benefits are considered taxable for those affected?
- The cost of up to $50,000 in group-term life insurance.
- Premium costs on accident and health insurance, short- and long-term disability insurance, and long-term care insurance.
- Meals and lodging furnished for the convenience of the employer.
- Employee achievement awards.
- Qualified transportation and moving expense reimbursements.
- Adoption assistance programs.
An S Corporation pays 80% of the cost of an employee’s health and dental insurance. That 80% will need to be reported on the 2% shareholder’s W2.
What do you do?
- The fringe benefits above are treated as compensation and are subject to employment taxes (FICA and FUTA) and also to federal withholding.
- Payments of health and accident insurance premiums are not considered wages and are therefore are subject only to federal taxes, not FICA and FUTA.
- The S Corporation reports these fringe benefits on the W2 of those affected.
- The S Corporation would deduct this additional compensation on Form 1120S as “Compensation of officers” or “Salaries and wages.”
- To the extent allowable, the 2% shareholders will deduct the taxable fringe benefits on their personal returns.
A real life example:
- An S Corporation pays 80% of the cost of an employee’s health and dental insurance. That 80% will need to be reported on the 2% shareholder’s W2.
- Most third party payroll providers are aware of these taxable fringe benefits and have codes to accomplish the reporting. Generally you can report these amounts per payroll, once per year (as long as the shareholder will have enough to cover the taxes in one check), or you can create a grossed up manual check in order for the company to cover the taxes.
- For cafeteria plan purposes, 2% shareholders (and their families) are considered owners rather than employees and can’t participate in the plan.