The Tax Implications of Fringe Benefits For Shareholders

Apr 26, 2016

An S Corporation is a very popular business entity with various tax advantages for shareholders. However, for two-percent shareholders, the IRS tax regulations for specific fringe benefits may be unclear. First, it is essential to first determine who is a two-percent shareholder. This is any person who owns (directly or indirectly on any day during the tax year) more than two percent of the outstanding stock of the total combined voting power.

Certain fringe benefits normally excluded from an employee’s taxable wages are required to be included when provided to any two-percent shareholder. If these fringe benefits are not included in the shareholder’s W-2 Box 1, then they are not deductible by the corporation.

The most common fringe benefits affected by such rule are health, dental, and vision insurance premiums paid under a corporate plan or the amounts reimbursed by the S corporation for premiums paid directly by the shareholder. If a company has established an HSA account and makes contributions on behalf of employees, this fringe benefit is typically excluded from their compensation. However, for a two-percent shareholder, these must be included in compensation. These premiums are subject to federal and state withholding, but not FICA or FUTA. The two-percent shareholder must take an above the line deduction for self-employed health insurance on their 1040 for the premium amount included in Box 1 of the W-2 from the S corporation.

A two-percent shareholder is not eligible to participate in a cafeteria plan, nor can their spouse or child. If a two-percent shareholder is permitted to participate, the plan may lose its tax-qualified status thus resulting in the provided benefits becoming taxable to all participating employees. As such, employees would not be able to make pre-tax salary reduction elections to obtain any benefits offered under the plan. Typically, such benefits may include dependent care assistance, adoption assistance, portions of health insurance premiums paid by the employee and health savings account contributions.

Other taxable fringe benefits can include qualified transportation, qualified adoption assistance, contributions to a medical savings account made by the employer, and qualified moving expense reimbursements. All of the above must be included as compensation for any two-percent shareholders. These fringe benefits are subject to FICA, FUTA, federal and state withholding.

This brief overview provides a glimpse into the complexities which may be encountered as a two-percent shareholder of an S Corporation. If your organization utilizes a payroll service, make sure such information is conveyed so a proper W-2’s can be submitted. If payroll is being completed in-house and additional guidance is necessary, please contact a payroll specialist at William Vaughan Company for assistance.

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