S Corporation Compensation & Medical Insurance Issues
REASONABLE COMPENSATION REQUIREMENT
S Corporations MUST pay reasonable compensation to a shareholder-employee in return for services that the shareholder-employee provides to the corporation BEFORE non-wage/non-deductible shareholder distributions may be made to the shareholder-employee.
Distributions and other payments by an S Corporation to a corporate officer (shareholder-employee) MUST be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.
Under IRS Section #7436, the IRS has the authority to reclassify payments made to shareholder-employees from non-wage distributions (which are not subject to payroll employment taxes) to wages (which are subject to payroll employment taxes).
TREATING MEDICAL INSURANCE PREMIUMS AS WAGES
Health and accident insurance premiums paid on behalf of a GREATER THAN 2% S Corporation Shareholder-Employee are deductible by the S Corporation and reportable as wages on the shareholder-employee's Form W-2.
They are subject to federal income tax withholding. However, these additional wages are NOT subject to Social Security Tax Withholding or Medicare Tax Withholding (FICA), or Federal Unemployment Tax (FUTA) if the payments of premiums are made to OR on behalf of an employee under a plan or system that makes provision for all or a class of employees (or employees and their dependents).
Therefore, these additional wages (compensation) are included in the shareholder-employee's BOX 1 (wages) of Form W-2, but are not included in BOXES 3 and 5 of Form W-2.
POSSIBLE ABOVE-THE-LINE-DEDUCTION ON FORM 1040
The greater-than-2%-shareholder-employee may be eligible for an above-the-line-deduction in arriving at Adjusted Gross Income on their Form 1040 for amounts paid during the year for medical care premiums if the medical care coverage was established by the S Corproation and the shareholder-employee meets the other self-employed insurance deduction requirements. If however, the shareholder-employee or the shareholder-employee's spouse was eligible to participate in any subsidized healt care plan, then the shareholder-employee is NOT entitled to the above-the-line-deduction per IRS Section #162(l).
HEALTH INSURANCE PURCHASED IN THE NAME OF THE SHAREHOLDER-EMPLOYEE & ABOVE-THE-LINE-DEDUCTION ON FORM #1040
Insurance laws in some states do not allow a corproation to buy group health insurance when the corproation only has one employee (i.e. the sole shareholder-employee). Therefore, if the shareholder was the sole employee of the corproation, then the shareholder has to purchase health insurance in his or her own name.
IRS Notice 2008-1 provided rukes by which a greater-than-2% shereholder-employee would be allowed an above-the-line-deduction even if the health insurance policy was purchased in the name of the sharholder-employee.
If the shareholder-employee purchased the health insurance in his'her own name and paid for it with his/her own funds, the shareholder-employee would NOT be allwoed an above-the-line-deduction.
If the corporation obtains and pays for health insurance in its name, covers the shareholder-employee under the policy, and reports the premiums as W-2 wages to the shareholder-employee, then the shareholder-employee IS allowed an above-the-line-deduction.
If the shareholder-employee purchased the health insurane in his/her own name but the S Corproation either directly paid for the health insurance OR reimbursed the shereholder-employee for the health insurance and also included the premium payment in the shareholder-employee's W-2, the shareholder-empoyee would be allowed an above-the-line-deduction.
BOTTOM LINE: In order for a shareholder-employee to claim an above-the-line-deduction, the health insurance premiums must ultimately be paid by the S Corporation and must be reported as taxable compensation wages on the shareholder-employee's W-2.
CALL NOW 561-746-1926 or 561-339-8102 if you have any questions or concerns or would like to schedule a FREE, Confidential, No-Obligation Tax-Saving Consultation.