When are company-paid health insurance premiums considered payroll? In the case of subchapter S corporations, the answer depends on ownership. Premiums paid for shareholder/employees who own more than 2% of the corporation stock are reportable as wages on the shareholder/employee’s Form W-2.
In most situations, the mechanics work this way. The corporation pays the premiums and reports them on Form W-2 as wages subject to withholding. The corporation takes a deduction for the premiums, and the shareholder picks up that amount as wage income. The shareholder can generally claim an above-the-line self-employed medical insurance deduction on the current year individual income tax return. Note that the premiums are typically not subject to social security and medicare taxes.
One easily overlooked wrinkle is identifying 2% shareholders. If, on any day of the taxable year, you own (or are considered to own) more than 2% of the outstanding stock of an S corporation you’re a “2% shareholder.” Note that “considered to own” means the family stock attribution rules apply (section 318 of the internal revenue code), so you’re considered to own the stock owned by your spouse, children, grandchildren, and parents.
In a memorandum issued by the Office of Chief Counsel (number 201912001) the question was whether a person who is a 2% shareholder due to the family stock attribution rules could claim the self-employed health insurance deduction.
The taxpayer, an individual, owned 100% of an S corporation. The S corporation employed a family member of the taxpayer. The family member was considered a 2% shareholder under the attribution of ownership rules. The S corporation provided a group health plan for all employees, and the amounts paid by the S corporation under the plan were included in the family member’s gross income.
Here’s the relevant tax law.
From internal revenue code section 162(l)(1)(A): Allows an individual who is an employee to take a deduction in computing adjusted gross income for amounts paid during the taxable year for insurance that constitutes medical care for the taxpayer, his or her spouse, and dependents.
The deduction is not allowed to the extent that the amount of the deduction exceeds the earned income derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established.
Also, the deduction is not allowed for amounts during a month in which the taxpayer is eligible to participate in any subsidized health plan maintained by an employer of the taxpayer or of the spouse of the taxpayer.
From section 1372 of the internal revenue code: Provides that, for purposes of applying the income tax provisions of the code relating to employee fringe benefits, an S corporation shall be treated as a partnership, and any 2% shareholder of the S corporation shall be treated as a partner of such partnership.
From revenue ruling 91-26: Accident and health insurance premiums paid or furnished by an S corporation on behalf of its 2% shareholders in consideration for services rendered are treated for income tax purposes like partnership guaranteed payments. An S corporation is entitled to deduct the cost of such employee fringe benefits. The premium payments are included in wages for income tax withholding purposes on the shareholder-employee’s Form W2, Wage and Tax Statement, but are not wages subject to social security and medicare taxes if the requirements for exclusion are satisfied.
From revenue ruling 92-26: A 2% shareholder-employee in an S corporation, who otherwise meets the requirements of section 162(l), is eligible for the deduction under section 162(l) if the plan providing medical care coverage for the 2% shareholder-employee is established by the S corporation.
From internal revenue service notice 2008-1: The 2% shareholder is required to include the amount of the accident and health insurance premiums in gross income. In order for the 2% shareholder-employee to deduct the amount of the accident and health insurance premiums, the S corporation must report the accident and health insurance premiums paid or reimbursed as wages on the 2%-shareholder-employee’s Form W-2 in that same year. In addition, the shareholder must report the premium payments or reimbursements from the S corporation as gross income on his or her Form 1040, U.S. Individual Tax Return.
WHAT WOULD YOU DECIDE?
Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions and IRS documents. The full documentation may include facts and issues not presented here. Please use the link provided in the post to read the entire document.
This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.
An individual who is a 2% shareholder of an S corporation pursuant to the attribution of ownership rules under section 318 is entitled to the deduction under section 162(l) for amounts that are paid by the S corporation under a group health plan for all employees and included in the individual’s gross income, if the individual otherwise meets the requirements of section 162(l).