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SO THEY SCREWED UP THE S CORPORATION OWNER'S W-2. NOW WHAT?

March 07, 2008

The following comment was posted to this old post:

As a fellow CPA, can I ask a question and get your thoughts? I have quite a few clients that had another company prepare the payroll and W2s and the SH Health insurance was not on the W2. What do you suggest doing?
My thought would be to deduct on 1120S, include as income on 1040, deduct against AGI (washing it out). Then, if it were to come under audit, at that point, issue W2cs and W3cs as necessary, as there would be zero change in the taxes for either entity. Thoughts?

This all comes out of IRS Notice 2008-1, which says that the only way for S corporation owners to get favorable treatment for health insurance is to have it included on their W-2; they may then deduct the amount of health insurance included on the W-2 on LIne 29 of Form 1040.

The method suggested in the comment - just include the insurance amount in "other income" and backing it out on Line 29 - was commonly used before Notice 2008-1, as it pretty much gets you to the same place as putting it on the W-2. Unfortunately, the notice makes it clear that the IRS doesn't accept that do-it-yourself method. As far as they're concerned, if it's not on the W-2, it's not eligible for the Line 29 deduction and therefore must be taxed to the recipient:

In order for the 2-percent 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-percent shareholder-employee's Form W-2 in that same year.

Given that clear language, and especially given the newly-enacted preparer penalties, I think the commenter's suggested solution is unwise. A preparer who takes this approach is going against a clear IRS position. Unless the preparer adds Form 8275 to a return to disclose the position, he is exposed to either a $250 or $1,000 penalty; such penalties could also lead to trouble with state accountancy regulators.

I would amend the W-2s. Amending the W-2 and W-3 reports for the affected shareholders is a hassle, but far less so than trying to explain a preparer penalty to a state Board of Accountancy.

IF IT'S NOT ON THE W-2, S CORP SHAREHOLDERS CAN'T DEDUCT HEALTH INSURANCE

ANOTHER QUESTION ON S CORPORATION HEALTH INSURANCE

Tags: Notice 2008-1.S corporations.