[fname], I am sending this email for 2 important reasons. 


One because of the importance of the information in this article below on S Corporations and two, if you did not listen to my webinar last week (click here for the replay) on Obamacare, that the program no longer allows employers, with less than 50 full time employees and not required to provide health insurance to employee, to reimburse or give employees any money for buying health insurance on their own with a separate check.

All reimbursement must be done through their payroll checks. This is the same for the owner and his/her family members on payroll

Thanks for taking the time to read the above. 

Now for the article on S Corporation's Fringe Benefit Realization.

Tax Tips for the S Corporation's Fringe Benefit Realization

Your S corporation may not give you the tax-free fringe benefits you desire.

In the good old days, the S corporation avoided double taxation, reduced self-employment taxes, and also gave you all the fringe benefits.

The good old days are long gone (since 1982).

When the S corporation is your 2011 business entity of choice, you give up some fringe benefits for this entity choice.

Two Questions to Ask

How much does this giveback cost you in after-tax dollars? That’s a question that you need to consider.

In this article, we give you the single best route to finding this answer. Second, what is the best way for you and the S corporation to deal with this giveback of fringe benefits? That depends. This article gives you a clear analysis of the three possible giveback methods.

The 2 Percent Shareholder Problem

The law taxes any fringe benefits received by employees who own a greater than 2 percent interest in an S corporation as if they were partners in a partnership. Tax law limits the fringe benefits that are available to partners.

Thus, the S corporation can have two types of employees:

1. The more than 2 percent owner-employee (the partner for fringe benefit purposes)
2. The 2 percent or less regular employee

Fringe Benefits Lost

The S corporation may not provide the more than 2 percent owner-employee with the following tax-free fringe benefits:

- Amounts paid to an accident or health plan
- Group term life insurance coverage (which is excludable on a regular employee up to the first $50,000 of coverage)
- Meals or lodging furnished for the employer’s convenience
- Tax-free benefits provided under a cafeteria plan

No-Problem Fringe Benefits

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 minimis fringe benefits
- On-premises athletic facilities
- Medical savings accounts

Net Cash Cost of Giveback

Since you lose fringe benefits with the S corporation, is the S corporation the entity that is giving you the best after-tax cash return? How much are you saving on double taxation? How much are you saving on self-employment taxes? What is your risk factor? These are questions you need answered.

Question. How would you know how much after-tax cash you gain or lose with the S corporation?

Answer. Do a three-column side-by-side comparison with the S corporation in column 1, the proprietorship in column 2, and the C corporation in column 3.

To ensure that you get this right, you should use your tax advisors. Ask them to set forth in dollars and cents your tax wins and losses with the entity choices available to you. This will cost you some billable time, but it is money well spent.

Three Strategies for the Owner’s Disallowed Fringe Benefits

You and your S corporation have three tax choices for treating 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

Choice 1: W-2 Compensation

The S corporation may treat the disallowed fringe benefit as W-2 compensation to the owner-employee. In this case,

- the corporation deducts the fringe benefit as compensation to the owner-employee, and
- the owner-employee receives the fringe benefit as taxable compensation.

For sure, this is what you want to do with health insurance or an S corporation Section 105 medical plan.

W-2 is the only way for health insurance. As the article above explains, the S corporation owner employee needs the W-2 recognition of the corporate-paid health insurance to realize a deduction on his or her personal tax return. In effect, no W-2, no Form 1040 page 1 deduction for the health insurance.

The good news is that the W-2 recognition of the S corporation’s payment of the owner-employee’s health insurance is not subject to FICA or Medicare.

When to avoid the W-2. W-2 recognition of the disallowed fringe benefits other than medical is subject to FICA and Medicare taxes.14 Accordingly, limit your W-2 recognition to medical. How do you do that?

Use either choice 2 or 3 below to keep the other tainted (and therefore taxable) fringe benefits off the W-2.

Choice 2: Distribution

In this choice, the S corporation makes disallowed fringe benefits a distribution by the corporation to the S corporation owner-employee.

The word "distribution" in this context is pretty much the same as dividend in the C corporation context in that the distribution is coming from income on which the S corporation owner has already paid the taxes.

With this approach,

- the S corporation has no tax deduction, and
- the owner-employee has no taxable income.

Thus, the disallowance of the fringe benefit does not trigger any additional loss because of payroll taxes.

Remember, you do not want to use this approach with the health insurance fringe benefit.15 Without the W-2 for medical, the owner of the S corporation loses the Form 1040 page 1 medical deduction on his or her personal tax return.

With the one-owner S corporation, there are no complications in using the distribution strategy for disallowed fringe benefits other than medical. However, should the S corporation have 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.

Choice 3: Reimburse the S Corporation

In choice 3, the owner-employee reimburses the corporation for the cost of the fringe benefit. With the reimbursement, the owner-employee is paying for the fringe benefit personally.  This does not work for health insurance.

However, like the distribution method above, the reimbursement method avoids FICA and Medicare taxes and works perfectly for disallowed fringe benefits other than medical.

Further, the S corporation owner who does 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 one-owner S corporation often plays with fire with its owner-employee advance accounts and loan amounts. Thus, you should strongly consider making the reimbursement in a timely manner before the corporation closes its year. In other words, avoid advances and loans.

Final Thoughts

Before worrying about how you and your S corporation are going to deal with fringe benefits, examine the question of the S corporation itself. Is this the business entity that is putting cash in your pocket?

Once you decide that the S corporation is the best choice for you, then consider how to treat the disallowed fringe benefits. Keep these points in mind:

1. You absolutely, positively want to have the S corporation report the heath insurance on a W-2 to the owner employee.
2. The health insurance on the W-2 is exempt from FICA and Medicare.
3. Group life, meals and lodging, and cafeteria plan benefits reported on the W-2 are not exempt from FICA and Medicare.
4. You can save FICA, Medicare, and other payroll taxes on the disallowed group life, meals and lodging, and cafeteria plan disallowed benefits by using either the distribution or the reimbursement method.

If you have any questions please feel free to call me here at the office.

Of course with something this new don’t expect us to have all the answers. Thank you.



Monica Rebella, CPA/IAR
507 E. First Street #A
Tustin,CA 92780
ph (714) 619-0667
Fax (714) 544-0236
email: mrebella@rebellacpa.com

This document was not intended or written to be used, and it cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties.


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