Certain otherwise excludable fringe benefit items are required to be included as taxable wages when provided to a 2% S Corporation shareholder. A 2% shareholder is any person who owns – directly or indirectly, on any day during the taxable year – more than 2% of the outstanding stock or stock possessing more than 2% of the total combined voting power of the corporation.
These fringe benefits are generally excluded from the income of other employees but are taxable to 2% S corporation shareholders similar to partners. If these fringe benefits are not included in the shareholder’s Form W-2, they are not deductible for tax purposes by the S corporation. The disallowed deduction creates a mismatch of benefits and expenses among shareholders, with some shareholders paying more tax than if the fringe benefits had been properly reported on Form W-2.
Health, dental, vision, hospital and accident (AD&D), and qualified long-term care insurance premiums
Premiums paid under a corporate plan are subject to FITW and SITW but not to FICA or FUTA. The amounts include premiums paid by the company on behalf of a 2% S corporation shareholder, as well as amounts reimbursed by the company for premiums paid directly by the shareholder. If the shareholder partially reimburses the S corporation for the premiums using post-tax payroll deductions, the net amount of premiums must be included in the shareholder’s compensation.
Pre-tax payroll deductions cannot be used by 2% shareholders to reimburse premiums paid by the S corporation. However, 2% shareholders can deduct the premiums using the self-employed health insurance deduction their personal federal income tax return (i.e., on Form 1040).
A 2% S corporation shareholder is not eligible to participate in a cafeteria plan created under IRC Section 125, nor can the shareholders’ spouse, child, grandchild or parent participate. If a 2% shareholder (or any other ineligible participant, such as a partner or nonemployee director) is allowed to participate in a cafeteria plan, the cafeteria plan will lose its tax-qualified status, and the benefits provided will be taxable to all participating employees, nullifying any pretax salary reduction elections to obtain any benefits offered under the plan.
Employer contributions to health savings accounts and other tax-favored health plans
This fringe benefit is subject to FITW and SITW but not FICA or FUTA. If the shareholder partially reimburses the S corporation for the health plan contribution, using post-tax payroll deductions, the net amount of the contribution must be included in the shareholder’s compensation. Pre-tax payroll deductions cannot be used by 2% S corporation shareholders to reimburse plan contributions paid by the company. However, 2% owners can take a corresponding self-employed deduction for the cost of their health savings account contributions on their Form 1040.
Short-term and long-term disability premiums
For 2% S corporation shareholders, employer-paid short- and long-term disability premiums are subject to FITW and SITW, but not to FICA or FUTA. Because the disability insurance premiums are paid with after-tax dollars, any disability insurance proceeds generally would be tax-free.
Group term life insurance coverage
Group term life insurance premiums should be included in Boxes 1, 3 and 5 of a 2% S corporation shareholder’s Form W-2. The entire premium paid on behalf of a 2% shareholder under a group term life insurance policy is treated as taxable, not just the premium for coverage in excess of $50,000. Although the value is taxable income to the 2% shareholder, the cost of the insurance coverage (i.e., the greater of the cost of the premiums or the Table I rates) is only subject to FICA tax withholding. The cost of the insurance coverage is not subject to FUTA, FITW or SITW. It should be noted that any life insurance coverage for which the corporation is both the owner and beneficiary (e.g., key man life insurance) does not meet the definition of group term life insurance and, therefore, there is no income inclusion in the shareholder’s Form W-2.
Other taxable fringe benefits
Employee achievement awards, qualified transportation fringe benefits, qualified adoption assistance, qualified moving expense reimbursements, personal use of employer-provided property or services, and meals and lodging furnished for the convenience of the employer must be included as compensation when made available to 2% S corporation shareholders. All of the above fringe benefits are subject to FICA, FUTA, FITW and SITW.
Nontaxable fringe benefits
The following fringe benefits are not includible in the compensation of 2% S corporation shareholders:
- Qualified retirement plan contributions
- Qualified educational assistance up to $5,250 (but tax-free benefits are not available if more than 5% of the educational assistance benefits are provided to 2% S corporation shareholders, their spouses or dependents)
- Qualified dependent care assistance up to $5,000 (but tax-free benefits are not available if more than 25% of benefits paid during the year are provided to individuals who own more than 5%)
- Qualified retirement planning services
- No-additional-cost services
- Qualified employee discounts
- Working condition fringe benefits
- De minimis fringe benefits
- On-premises athletic facilities
Check out our prior post on employee fringe benefits and the CARES Act changes.
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