Anyone who runs a company knows that there’s usually an opportunity to classify the business as an S Corporation. There are various reasons to do this, and talking to a business attorney can give you some insight. The simple explanation is that an S Corp status offers some of the benefits you’d get from being a corporation. Also, you get some of the benefits you’d get from being a Limited Liability Company (LLC). But if you’ve elected S Corp status and you offer health insurance to employees, you should be aware of what’s called the ‘2% shareholder health insurance’ rule.
Are we an S Corp?
The first step you’ll want to take is determining if you are an S Corp. If you’re not familiar with your corporate status, you can do this by asking your accountant or business attorney if your company has ever elected S Corp status. You can also ask the the CEO, President, Founder, or another senior level employee whether the organization is an S Corp. If you are the senior-most company leader, and neither you, your business attorney, nor your accountant knows if you’re an S Corp, chances are that you are not an S Corp.
Rules of an S Corp
The IRS places special rules on S Corporations, regarding who can own shares of the company, how much they can own, and how shareholders are treated if they own 2% or more of the company’s shares.
The IRS says that a 2% shareholder is a person, trust, or estate that owns more than 2% of the companies stock at any time during the calendar year. It also applies to individuals who own more than 2% of the company’s voting power.
If employees of the S Corp own more than 2% of the the company’s stock, their health insurance is treated differently than employees who do not own 2% or more of the company’s stock
When are health insurance premiums classified as fringe benefits?
Fringe benefits are benefits you can offer employees are calculated above and beyond regular wages. That means: they’re usually taxable. Health insurance is a type of fringe benefit that is usually NOT taxable to employees. Here’s the breakdown on nontaxable fringe benefits:
- Nontaxable fringe benefits: Examples of nontaxable fringe benefits include temporary life insurance coverage and health insurance coverage. As a nontaxable fringe benefit, health benefit contributions are exempt from income tax, Social Security and Medicare taxes, and federal unemployment tax withholding.
- Exception to the above: Health insurance for 2% shareholder-employees of an S Corp. If the company provides health insurance to employees who own more than 2% of stock in the S Corp, the premiums are tax deductible for your company. But, the premium amounts are taxable for your employees. You need to include the amount of health insurance premium in that employee’s payroll documentation and taxable wages.
There’s some silver lining to this exception. These contributions are not subject to Social Security and Medicare (FICA) taxes or unemployment tax (except in Pennsylvania). If you are an S Corp owner in Pennsylvania, contact your state for more information.
Some practical advice we recommend from Patriot payroll services on how to account for this on a W-2:
Write the value of the shareholder-employee’s health insurance in box 14, “Other,” of their Form W-2. You will also include the additional compensation in box 1, “Wages, tips, other compensation”. Because the contributions are not subject to Social Security and Medicare taxes, do not include the amount in box 3, “Social Security wages” or box 5, “Medicare wages and tips”. The health insurance benefit is only subject to income tax. For more information on S corporation shareholder health insurance, contact the IRS.
If you want to learn more about how to optimize your payroll and insurance coverage strategies, reach out to the team at Suitless. Our Core HR service also provides insight and advice into real life business situations. We work directly with insurers and state agencies to make sure companies and employees get the best benefits.