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.
UPDATE II: January 28, 2009
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
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