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S CORPORATION HEALTH INSURANCE: READER QUESTIONS
January 02, 2008
The S corporation health insurance issues raised in Notice 2008-1 have prompted some reader questions in comments for our two previous posts (here and here) on the subject. Keep in mind that I don't know the questioners, and they're not paying me, so they should talk to their own tax advisors before doing anything. That said:
I have an S corp setup which pays me & my wife a salary with all taxes taken out just as a normal paid employee. How does this new ruling affect how I should do my 2007 taxes as far as health insurance?
S corporation owner employees have long been required to add back their company-paid health insurance on their W-2s as taxable "Box 1" income. While the premium payments are included in taxable income, they don't have to be included in taxable wages for Medicare and FICA tax purposes. The employee then deducts this amount "above the line" on line 29 of form 1040. This gets you to the same place as if it had not been included in income to begin with.
The effect of Notice 2008-1 is to say that the only way to have S corporation shareholder-employee health premiums treated as "pre-tax" deductions is to include it on the W-2 Box 1 and deduct it on line 29. Other shortcuts - such as adding it back on form K-1 as a separate information item, or issuing a 1099, or just omitting it from W-2 income - don't work. If you don't do things as set out in Notice 2008-1, the IRS will say that the premiums are taxable income, but you get no line 29 deduction.
I had been using the www.association105.com program which their advertised tax benefit is not to having to pay SS/Medicare taxes on all my healthcare expenses including out of pocket. Is the service still necessary now that this new notice is effect?
Not knowing specifically about your plan, you might want to note that S corporation 2% shareholders are not eligible to exclude Sec. 105 benefits from Box 1 income; the IRS said in Announcement 92-16 that such benefits may be excludible from FICA and Medicare tax. You might be able to do as well using a health savings account arrangement, though; see Notice 2005-8.
I'm setting up a new Quickbooks payroll service. With this new notice how should I set up the payroll to take maximum advantage of this new notice- is this to be filed under fringe benefits, S corp owners health insurance, etc? And is it pretax or after tax expense. I just want to make sure I get it right since its a initial setup.
Health insurance is pre-tax for FICA and Medicare purposes, but after-tax for Box 1 taxable income.
A question referring to the treatment required by Notice 2008-1:
I am not sure this makes sense.1. By doing the above, would we increase payroll taxes for the shareholder-employee?
2. What is the benefit of doing this? Doesn't the shareholder-employee deduct insurance payments on line 25 and 29 already, with income passed through on line 17? What difference does it make to have the income on line 7?
Does it make sense? Look, Notice 2008-1 is the IRS talking, not me. They're saying that inclusion on the W-2 is the only way for S corporation shareholder-employees to get tax-favored treatment for their health premiums. The benefit of following the 2008-1 rules is that the IRS won't disallow the deductions on line 29 for self-employed health insurance.
The premiums are not supposed to be included in line 17 of the 1040 (where shareholder K-1 income is reported) because the corporation deducts the premiums as compensation expense, which reduces the line 17 amount. It goes on the W-2 to assign the health insurance to the shareholder-employee to which it applies. If you just disallowed the expense, other shareholders, including ones that aren't employees, would bear the tax cost - and non-employee shareholders don't get the line 29 deduction.
Putting the income in box 1 doesn't increase FICA or Medicare tax, as outlined above. It may increase state payroll taxes.
UPDATE, 3/7/08: I address a question from the comments to this post here.
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Comments
Man, great explanations! It took me reading this over a few times to finally get it- taking the healthcare expense back off on line 29 certainly seems to simplify things.
-But to clarify since you must include the health premiums on Box 1 taxable income and take it off on line 29 does it even matter whether the money to pay the health care premiums is paid from the S corporations account or my personal account?
For example, it would seem that if person "A" made $30,000 salary & had $5000.00 health expenses by having the expenses paid from the S corp's account and not the employees personal account after payroll taxes you would avoid paying the matching tax payments for Medicare & Social Security on that $5000.00 or maybe State payroll taxes. Is this correct?
Posted by: John | January 2, 2008 7:52 PM
John, to be deductible on line 29, the money to pay premiums has to either be remitted to the insurance provider by the employer, or the employer has to reimburse the shareholder-employee for documented premium expenses. By following Notice 2008-1, the expenses are deductible. If you don't follow notice 2008-1, the premiums are not deductible, so they come out of after-tax earnings.
Posted by: Joe Kristan | January 3, 2008 7:02 AM
My concern is with the definition of earned income for this purpose. All the examples in Notice 2008-1 assume the S corp shareholder has earned income from the S corp, which is defined in section 401(c)(2) as self-employment income. But S corps don't generate self employment income. Do the wages count as earned income for this purpose? (So as long as the wages exceed the premiums the shareholder can get the line 29 deduction?) The Notice doesn't say so.
What if the S corp has a loss? if the wages exceed the premiums and both the wages and the premiums create a loss, does the shareholder still get the line 29 deduction?
Posted by: Joe Lanza | January 4, 2008 12:20 PM