I recently started working for an s corp. there are two shareholders which each own 50% and work in the company consistently. the company offers health insurance. however, one shareholder does not use this insurance and has personal health insurance and has been using the company to reimburse him/her through distributions. On the books, distributions have been equal. However, according to the IRS, this is a fringe benefit and has to be considered as wages, reported on the W2 in box 1 and considered as taxable income. ( I called and asked.)

Since this was a fringe benefit, can it also be a distribution? (I really don't think so.) Since this has to be reported as wages, does this make the distribution balance unequal? If so, how do I correct this problem before 2013 W2's are printed?

#1;Health and accident insurance premiums paid on behalf of a 2% shareholder are reported as additional compensation to the shareholder. The value (normally cost) of the fringe benefit is added to the 2% shareholder’s wages. (However, the premiums can avoid employment taxes if made under a plan for employees and their dependents, or for a class of employees and their dependents.) .Since the 2% shareholder is not considered an employee for fringe benefit purposes, he or she cannot exclude the cost of the health insurance premiums from gross income as employer-provided coverage. However, the 2% shareholder may be able to claim the self-employed health insurance deduction. The deduction is not available for calendar months in which the 2% shareholder or spouse is eligible to participate in another employer-subsidized health insurance plan. Furthermore, the deduction is limited to the 2% shareholder’s earned income (i.e., the social security wages the shareholder receives from the corporation). Any portion that exceeds the earned income limitation is deductible as an itemized deduction, subject to the 10% (in 2013 unless the shareholder is over 65 yo.) of AGI floor for itemized medical deductions. When taxable fringe benefits are included in wage income, all shareholders will share in the corporation’s additional compensation deduction, according to each shareholder’s percentage ownership in the corporation (under the normal per-share, per-day allocation rules).

#2;Fortunately, payments of health insurance premiums for shareholders will not be considered distributions for purposes of the one-class-of-stock rule. Furthermore, fringe benefit programs are not considered “governing provisions;” therefore, providing fringe benefits will not create a second class of stock unless they are part of a plan to circumvent the one-class-of-stock rule.


#3;As the ownership percentages are equal, then the income and expenses reported to each owner will be equal. The IRS doesn't care if distributions are equal, but the actual distributions are tracked and reported through the Form K-1. If one owner gets more back in distributions than his basis (cost plus assumed liabilities), then some of distribution will be taxable. (Distributions reduce basis, but basis cannot go below zero.) .The S-Corp is required to file the forms correctly, which would include showing the amounts actually distributed to each shareholder on sch k1. Distributions of the income of a business which elected an S corp status are directly proportional to the percentage of ownership for each shareholder and called wages or salary. However, under some circumstances, the business' profits may not be evenly distributed according to ownership. The IRS refers to this disproportionate amount as a dividend, not to be confused with C corp dividends. A dividend is an uneven distribution to one or several of the S corp owners. You probably want A CPA/an EA in your local area for more info in detail in doing the S-Corp return ...

Thanks for the information. I think I am on the right track. I have explained this to the owner before and I don't think she understands.

Can you please explain how I am supposed to fix what she has already done? I am expected to do W2's, not the CPA. No matter what, I am expected to do W2's.

Sorry I can't tell you;it depedns. Needless to say, An S Corp needs to carefully monitor distributions to shareholders to be certain that there are no disproportionate distributions. Failure to make distributions in proportion to ownership interests can void the S Corp election.

Distributions to shareholders must be made in proportion to the ownership interests of the shareholders or a disproportionate distribution has occurred. For example, as the S Corp has two shareholders owning 50% of the corporate stock, all distributions to shareholders should be in this ratio. These are distributions of profits, since the shareholders is also an employee, amounts paid to him in salary/wage are not distributions for this purpose.As the S corp can deduct payments in excess of 2 percent of the total amount paid toward shareholder's medical insurance plan(In other words, the premiums are included in the shareholder/employee's salary.), on his income tax filings, the shareholder then claims the sum deducted by the corporation as income. The 50% shareholder/employee of the S corp may be able to take an above-the-line deduction on his individual income tax return for the premiums paid by the S corp (or reimbursed to the shareholder if the shareholder pays the premiums).An above-the-line deduction is a deduction that may be claimed even if he doesn't itemize his deductions. In other words, he simply claims the deduction on the front of Form 1040 to arrive at AGI. I guess th S corp needs to determine and acquire the types of tax forms it needs to file. However, whether or no the, as a 50% shareholder of the S corp, may claim an above-the-line deduction on his personal tax return for health insurance premiums depends on whether he or the S corp is considered to have established the health insurance plan.Whether he or the S corp is considered to have established the plan depends on who pays the premiums and how the premiums are reported for income tax purposes rather than whose name the policy is in. If the plan is considered to have been established by the S corp( I guess this is his case), then he may claim an above-the-line deduction for the premiums paid on the front of Form 1040; If the plan is considered to have been established by him, then he cannot take an above the line deduction.
He could, however, take a deduction for the premiums he paid as a medical expense on Sch A, of Form 1040 If he itemizes his deductions.

Medical expenses deducted on Sch A must exceed 10%, I guess for 2013 of AGI to get any tax benefit. When preparing his state return the 10% limitation may not apply. For example, in AZ, you may deduct 100% of your medical expenses if you itemize your deductions. He needs to check the rules for your state.

S corps need to be concerned with deducting accrued shareholder salary. For quarterly IRS filings, S corps use IRS Form 941; for annual filings, they use Form 1120S. The IRS requires corps to report wages and all other forms of compensation and any taxes the corporation withheld, as well as tips, sick pay and benefits. The total sum paid to employees and shareholders can be deducted from a company's tax-paying obligations.I guess he needs to contact a CPA/an EA in his local area for more info in detail for fed/state returns.

Just two more questions.

1) since the one shareholder has a fringe benefit, and this affects salary, are shareholders of an s corp required to have an equal salary?

2) do HSA's qualify for the insurance according to the IRS?

Thanks so much for helping out in this issue! I am just a bookkeeper but my boss thinks I should know all this tax info as well!!

#1;As long as the ownership percentages are equal, then the income and expenses reported to each owner will be equal.

Also, the IRS doesn't care if distributions are equal, but the actual distributions are tracked and reported through the Form K-1. If one owner gets more back in distributions than his basis (cost plus assumed liabilities), then some of distribution will be taxable. (Distributions reduce basis, but basis cannot go below zero.)





#2:When your S Corp makes a payment to an HSA account on behalf of its employees, the employees own their HSA accounts. As a result, the S Corp’s contributions to the employees’ HSA accounts become the employees’ property.
The corporation’s HSA contribution is a tax-free fringe benefit to the employee that is reported on the employee’s Form W-2 in box 12, using the code “W.”
While the employee receives a tax free fringe benefit, your S Corp deducts the contributions to the HSA as an employee benefit program expense.
If, you are a more than 2 percent shareholder, then contributions by your S Corp to your HSA are also deductible, in the form of compensation, by the corporation.
For employment tax purposes, the S Corp treats the HSA contributions as wages subject to income tax withholding (but exempt from FICA and Medicare taxes).
While you pick up the HSA contributions as income on your W-2, you can deduct the HSA payments made by the S Corp on your Form 1040 and, effectively, you have a wash for tax purposes. But the advantage is you save on payroll taxes by having the S Corp pay your HSA.
And remember, S Corp owners who pay their medical insurance premiums personally are not eligible to claim the self-employed insurance deduction on page 1 of their Form 1040. The deduction is only allowed when the plan is established by the corporation.

I was reading about a problem with S corps. My boss is stressing because the shareholder-employee salaries will not be equal this tax year. I was looking up the effects of this and if s corps whose shareholders own more than 2% are required to be equal. When I was looking this up, I found a requirement called Qualified Personal Service Corporations and my company qualifies. However, I was wondering if this link is just for C Corps or both S and C Corps.


http://www.irs.gov/pub/irs-pdf/i1120w.pdf