Taxation of Health Insurance for S Corp Owners
S corporation owners may get some tax benefit from heath insurance costs, which many overlook.
About S CorporationSubchapter S corporations are not new. Taxpayers have been able to make S corp elections since the late 1950s. As taxes have steadily increased (particularly in the 1980s-1990s), the S corp became one of the most favored choices for small and medium-sized businesses. IRS statistics show that S corporations are more prevalent than partnerships and C corporations by far.
One reason for its popularity is the ability to avoid some employment or payroll taxes on amounts received by the shareholder. This savings can be significant. Another reason for its popularity is that the S corp rules can be easier to understand than than the complex partnership tax rules. The S corp rules also allow for some specific types of tax planning for real estate developers and others.
But these benefits can come at a cost. The limits on fringe benefits for shareholders is one such cost.
2% Shareholder RulesCongress put some limits on non-wage payments made by a S corp to its shareholders. This includes limits on payments for health insurance.
Generally, S corporation shareholders are treated as partners are with respect to payments for health insurance. Accident and health insurance premiums paid or furnished by the S corp on
behalf of its 2% shareholders are treated like partnership guaranteed payments under § 707(c). The S corp is generally entitled to deduct the cost of these payments under § 162(a) and the premium payments are included in wages for income tax withholding purposes on the shareholder-employee’s Form W-2. So where is the benefit?
The answer is that these amounts counted as wages are not subject to Social Security and Medicare taxes. There are requirements (found in § 3121(a)(2)(B) that have to be met for this exclusion). If met, this can save the S corp owner payroll taxes on the health insurance payments. This is one of several methods that S corp owners have to consider in deciding what mix of fringe benefits to offer.