S-corporation owners are disallowed certain fringe benefits. There are three methods taxpayers can use to deal with this loss of fringe benefits depending on the benefit. For fringe benefit purposes, S corporations have two types of employees:
- Owners: Employees who own more than 2 percent of the S corporation’s stock
- Non-owners: Employees who own 2 percent or less of the stock
If you are an owner-employee, you lose some of your fringe benefits. This is because the law treats owner-employees as if they were partners in a partnership which limits the fringe benefits that are available to partners.
For purposes of fringe benefits, the IRS treats your family as owning the same amount of stock that you do; this includes your spouse, children, grandchildren and parents.
If you are considered an owner you are not permitted to the following tax-free fringe benefits:
- Amounts paid to an accident or health plan
- Group term life insurance
- Meals or lodging furnished for the employer’s convenience
- Tax-free benefits provided under a cafeteria plan
The following fringe benefits are available to a partner in a partnership and, therefore, available to the more than 2 percent owner employee:
- Employee achievement awards
- Qualified group legal services plans
- Educational assistance programs
- Dependent care assistance programs
- No-additional-cost services
- Qualified employee discounts
- Working condition fringe benefits
- De minims fringe benefits
- On-premises athletic facilities
- Medical savings accounts
Taxpayers have three tax choices for how to treat the disallowed fringe benefits:
- W-2 compensation to the owner-employee
- Distribution to the owner-employee
- Reimbursement by the owner-employee to the S corporation
The S corporation may treat the disallowed fringe benefit as W-2 compensation to the owner-employee. The corporation can deduct the fringe benefit as compensation to the owner-employee and the owner-employee will receive the fringe benefit as taxable compensation.
This is the most common approach when dealing with health insurance benefits. The W-2 recognition of the S-corporation’s payment of the owner-employee’s health insurance is not subject to FICA or Medicare while W-2 recognition of the disallowed fringe benefits other than medical is subject to FICA and Medicare taxes.
As a result, this is not the most common approach on non-medical disallowed fringe benefits to prevent exposure to FICA and Medicare taxes.
The S corporation can also make disallowed fringe benefits a distribution by the corporation to the owner-employee. If this approach is utilized, the S corporation has no tax deduction and the owner-employee has no taxable income.
The disallowance of the fringe benefit will trigger any additional loss because of payroll taxes. This is not advantageous for health insurance fringe benefits because the owner of the S corporation will lose the medical deduction on their personal tax return.
When there is only one-owner in the S corporation, there are no complications in using the distribution strategy for disallowed fringe benefits other than medical benefits. If the S corporation has multiple owners, the S corporation distributions need to avoid preferential dividend treatment that could create a second class of stock and terminate the S corporation’s election.
Reimburse the S Corporation
The final option for the owner-employee is to reimburse the corporation for the cost of the fringe benefits. If the reimbursement is employed, the owner-employee pays for the fringe benefit personally. The reimbursement method avoids FICA and Medicare taxes and works for disallowed fringe benefits other than medical benefits.
S corporation owners who do not have previously taxed earnings in the S corporation adequate for a distribution should consider this method. If you are using the reimbursement method, you need to ensure settlement by December 31 or record the outstanding amount as a loan receivable by the corporation from the owner-employee.
The loss of some fringe benefits with the S corporation status is a component that should be taken into consideration when analyzing which entity structure is best suited for your business needs.
Camuso CPA PLLC’s focus and specialization delivers a unique perspective on best industry practices to provide the most value to clients.
Contact us today for financial and tax planning and get your finances in order: https://www.camusocpa.com/contact/#/