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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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Reimbursement for health insurance premiums vs. paying expenses

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Reimbursement for health insurance premiums vs. paying expenses under HRA.
I am an owner of S-corp. The corporation has two employee-owners: me and my partner, and one straight employee. In my state having total of three employees does not qualify for corporate group insurance plans. So we want everybody to get their individual plans and the corporation to reimburse the premiums to both employee-owners and straight employees.
My understanding is that in addition to that we can setup health HRA. We want ultimately corporation to reimburse employee-owners and likewise straight employees for the following:
1. Health insurance premiums
2. Out of pocket deductibles paid during doctor-visits and emergency room visits
3. Dental payments not covered by insurance
4. Prescription medication not covered by insurance
All 4 categories combined, in my vision, are subject to $3,000 per employee per year limit, which is the same for employee-owners and straight employees.
Question: is #1 different from all other categories from taxation stand point? I am about to treat them the same, would that be wrong?
How do I account for all that specifically when doing my payroll and taxes? I am using Intuit online payroll service. And then prepare my taxes using Turbotax software for business. Here is what I am about to do:
* When paying (reimbursing) for either of 1 to 4 categories to straight employees I am not putting any of it on payroll, respectively they are not going on employees W2. But when doing corporate 1120S I deduct them under I-18 “Employee benefit programs”
* When paying (reimbursing) for either of 1 to 4 categories to owner-employees I enter amounts in Intuit “S-Corp Owners Health Insurance”. (There is actually other category in Intuit called “Company HSA Contribution” – not sure what that is). Then when doing taxes this payments become part of owner-employees W2 and respectively I-7 deduction for “officers compensation”.
How wrong is that?
Submitted: 10 months ago.
Category: Tax
Expert:  Lev replied 10 months ago.

Lev :

Hi and welcome to our site!


There will be different treatment for a 2% shareholder-employee's. And there will be different treatment for these benefits.
Exception for S corporation shareholders. Do not treat a 2% shareholder of an S corporation as an employee of the corporation for this purpose. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation's stock or stock with more than 2% of the voting power. Treat a 2% shareholder as you would a partner in a partnership for fringe benefit purposes, but do not treat the benefit as a reduction in distributions to the 2% shareholder.


Contributions by an S corporation to a 2% shareholder-employee's HSA for services rendered are treated as guaranteed payments and are deductible by the S corporation and includible in the shareholder-employee's gross wages. The shareholder-employee can deduct the contribution made to the shareholder-employee's HSA on the individual tax return.


Heath and accident insurance premiums (including dental insurance premiums) paid on behalf of 2% S corporation shareholder-employee are deductible and reportable by the S corporation as wages for income tax withholding purposes on the shareholder-employee’s Form W-2. These benefits are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes. The additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement, issued to the shareholder-employee, but would not be included in Boxes 3 and 5 of Form W-2.

Customer:

Unfortunately you have restated that I already know. I know that (in may my case 50%) owner-employees are not the same as straight employees and I already treat them differently by entering owner’s insurance premiums reimbursements at “S-Corp Owners Health Insurance” in Intuit payroll software and *not* entering employee insurance premiums reimbursements into Intuit payroll software at all.


My question is about treatment of 4 different categories of reimbursements


1. Health insurance premiums.


2. Out of pocket deductibles paid during doctor-visits and emergency room visits.


3. Dental payments not covered by insurance.


4. Prescription medication not covered by insurance


Is there difference between them from payroll processing and taxation stand point? Also to lesser extend the question is about difference between HRA and HAS.


If you want a specific examples here are:



  1. Out single straight employee was prescribed by a doctor a $120 worth of medication not covered by his insurance plan. We want to reimburse him and take a corporate deduction. How do we do that? My understanding is it does not go on payroll, same treatment as his insurance premiums reimbursements.

  2. My partner (50% owner shareholder) went to a dentist and paid $470 out of pocket. We want to reimburse him and take a corporate deduction. My understanding is it goes on his payroll under “S-Corp Owners Health Insurance” then it respectively becomes part of his W2.


I am wrongs in such approach?

Lev :

Is there difference between them from payroll processing and taxation stand point?
Yes - there are differences


1. Health insurance premiums paid by S-corporation and by employee.
for the employee who is not a shareholder - not included into wages but deducted fringe benefits;
for the shareholder-employee - included into taxable wages - but not included into wages subject of FICA; deducted as wages.


2. Out of pocket deductibles paid during doctor-visits and emergency room visits.
Generally included into wages.


3. Dental payments not covered by insurance.
Similarly - included into wages.


4. Prescription medication not covered by insurance.
Included into wages.
For ##2-3 - you may set FSA or HSA and might be able contribute on pre-tax basis for the straight employee. But for for shareholder-employees - always included into wages.

Lev :

Out single straight employee was prescribed by a doctor a $120 worth of medication not covered by his insurance plan. We want to reimburse him and take a corporate deduction. How do we do that? My understanding is it does not go on payroll, same treatment as his insurance premiums reimbursements.
That reimbursement will be treated as fringe benefit. All fringe benefits are included into wages unless specifically excluded. Some fringe benefits are included into wages but on pre-tax basis.
Only specifically allowed fringe benefits are not included into wages - a common example is employer's part of health insurance premiums - see IRS publication 15b for details. So - the treatment will not be the same.
In your example - reimbursements for medical expenses should be included into wages. To exclude - you may set FSA - flexible spending account for medical purposes - so-called "section 125 cafeteria plan" - either employer or employee may contribute to FSA on pre-tax basis - and funds may be used to pay (or reimburse) for medical expenses. In this case S-corporation will deduct contributions to FSA as wages, but it will not be included into taxable wages of the employee.
That may not be used by shareholder-employees.

Lev :

My partner (50% owner shareholder) went to a dentist and paid $470 out of pocket. We want to reimburse him and take a corporate deduction. My understanding is it goes on his payroll under “S-Corp Owners Health Insurance” then it respectively becomes part of his W2. I am wrongs in such approach?
Your understanding generally is correct - because shareholder-employees are not treated as employee for fringe benefit purposes - all reimbursements are included into wages. However - health insurance premiums and other medical reimbursements are treated differently. While health insurance premiums are not subject of employment taxes - all other reimbursements are not excluded from FICA. If you treat dental out of pocket reimbursements as health insurance - you will incorrectly exclude that reimbursement from FICA.

Lev :

Health reimbursement arrangements (HRAs) excludable under § 105(b) may be used in your situation. An HRA reimburses the employee for medical care expenses incurred by the employee and provides reimbursements up to a maximum dollar amount with any unused portion of that amount at the end of the year carried forward to following years. An HRA is an arrangement that is paid for solely by the employer. If you choose that route - S-corporation must set HRA plan - and make contributions to this plan fro each employee. Subsequent reimbursements would be made from HRA to each employee. Generally HRA accounts are set with a third party. In this case - contributions to HRA are treated similar to medical insurance premiums - section 106 provides that the gross income of an employee does not include employer provided coverage under an accident or health plan.
However - in your example - when S-corporation provides direct reimbursements - the tax treatment is different.

Customer:

Thank you it is a little bit clearer now. But let me say this: I do not care about reimbursement if I cannot do it on pretax basis without including into wages. Because I can always issue a bonus to either non-owner employee or to owner-employee, which would have the same effect. Right? So I am looking for a way to reimburse non-owner employee in such way that it is deductible to a company and not taxable to employee, and for ways to reimburse owner-employee in such way that it is deductible to company and at bare minimum excluded from payroll taxes for owner-employee.


Tell me more about HRA. What does it mean I set them up with third party, who is this third party, is that expensive? Will it work the way I indent to (see above) for straight employees and S-Corp owner-employee? What happens to these accounts when employee leaves or I dissolve the corporation?

Expert:  Lev replied 10 months ago.
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Expert:  Lev replied 10 months ago.
So I am looking for a way to reimburse non-owner employee in such way that it is deductible to a company and not taxable to employee, and for ways to reimburse owner-employee in such way that it is deductible to company and at bare minimum excluded from payroll taxes for owner-employee.
That is easy to achieve with non-owner employee by providing deductible fringe benefits - see IRS publication 15b for details.
In case of shareholder-employees - the tax treatment is different - because shareholder-employees are not treated as employee for fringe benefit purposes - all reimbursements are included into wages.
However some saving are allowed for heath and accident insurance premiums - which are still included into wages - but are not subject of FICA. In additional - shareholder-employees might be eligible to deduct such premiums as adjustment to they income on individual tax return.
There are no ways to have fringe benefits deductible for the corporation and not included into wages of shareholder-employees. Th e situation would be different in case of C-corporation - but seems that is not an option.

Tell me more about HRA. What does it mean I set them up with third party, who is this third party, is that expensive?
You may have HRA with any financial company or with your bank - that should not be too expensive - but will trigger some overhead. That would be similar to IRA or retirement plan. Also employees may open HRA account individually.


Will it work the way I indent to (see above) for straight employees and S-Corp owner-employee?
Contributions by an S corporation to a 2% shareholder-employee's HSA for services rendered are treated as guaranteed payments and are deductible by the S corporation and includible in the shareholder-employee's gross wages.
See page 14 - http://www.irs.gov/pub/irs-pdf/p15b.pdf
A qualified individual must be covered by a High Deductible Health Plan (HDHP) and not be covered by other health insurance except for permitted insurance listed under section 223(c)(3) or insurance for accidents, disability, dental care, vision care, or long-term care. For calendar year 2013, a qualifying HDHP must have a deductible of at least $1,250 for self-only coverage or $2,500 for family coverage and must limit annual out-of-pocket expenses of the beneficiary to $6,250 for self-only coverage and $12,500 for family coverage.
So - that might work for regular employees, but will not work as intended for
shareholder-employees. If an employee may deduct such contribution or not is determined on the individual level.
Earnings inside HRA are not taxable (tax liability deferred), but qualified distributions for medical purposes are not taxable.

What happens to these accounts when employee leaves or I dissolve the corporation?
There will be similar treatment as for retirement plans - these HRA accounts are belongs to each employee and may be transferred to a different financial institution. Funds may be used for medical purposes only, distributions for other purposes are subject of penalty.
Customer: replied 10 months ago.

 


To summaries it looks like there is no really a good way for as owner-employee (>2%) of S-Corp to get reimbursement for dentist and prescription drugs, or even for health insurance premiums in such way that is deductible for corporation and not taxable in hands of owner-employee. Am I right?


How about this idea. This is probably not practical I will not do that because that would require running two payrolls, doing two tax returns and etc. But here is the setup. Insdead of being 50/50 owners in a single S-corp, my partner has S-Corp, I have another S-Corp. Each of us is 100% owner of the respective corporation. Further I am employee-owner on my corp and straight employee of my partner’s corporation. Same in reverse goes for my partner.


That way my partner can reimburse me for my medical bills and take deduction for his corp. And I can reimburse my partner and take nice deduction for my corp. And neither of us is liable for personal taxes. Other than accounting overhead described above are there any counter arguments against this schema?

Expert:  Lev replied 10 months ago.
To summaries it looks like there is no really a good way for as owner-employee (>2%) of S-Corp to get reimbursement for dentist and prescription drugs, or even for health insurance premiums in such way that is deductible for corporation and not taxable in hands of owner-employee. Am I right?
Yes - that is correct - not for S-corporation. But that would perfectly work for C-corporation.
The issue is that owner-employees are not considered "employees" form fringe benefit purposes.

How about this idea. This is probably not practical I will not do that because that would require running two payrolls, doing two tax returns and etc. But here is the setup. Instead of being 50/50 owners in a single S-corp, my partner has S-Corp, I have another S-Corp. Each of us is 100% owner of the respective corporation. Further I am employee-owner on my corp and straight employee of my partner’s corporation. Same in reverse goes for my partner.
As to satisfy formalities - idea is not bad - and I am impressed by your creativity.
However - in case of an audit - and if the IRS agent know all that information - the interpretation must be based on factual circumstances - and there is a risk that the IRS agent might disagree with your scheme.

Other than accounting overhead described above are there any counter arguments against this schema
?
Of cause - if you tell nothing and the agent would not be aware of such agreement - from formal point everything might look correct. However - to be honest - that is a tax avoidance scheme.
Customer: replied 10 months ago.

How about leaving our S-Corp intact with (50/50 ownership), but setting up additional C-corp with the same 50/50 ownership. There will be service agreement between S-corp and C-corp and C-corp will provide certain services to S-corp for a fee. The finances of new C-corp will structured such that it have no profit – ever! As employees of C-corp can me and my partner get described above reimbursements such way that they are deductible to C-corp and not taxable in our hands? Is that better in IRS eyes? Is it more accounting overhead to run C-corp than S-corp?

Expert:  Lev replied 10 months ago.
As employees of C-corp can me and my partner get described above reimbursements such way that they are deductible to C-corp and not taxable in our hands?
In eyes of the IRS - that is a tax avoidance scheme - assuming the IRS agent knows all facts and circumstances.
C-corporation which "structured such that it have no profit – ever" - might be questioned its business purposes - and business deductions might be questioned as well.
So far - I see no difference.
Again - to satisfy formalities- any of these schemes may be used - but neither is perfect - and there is a risk that the IRS agent in case of the audit could disagree with your interpretation.

Is it more accounting overhead to run C-corp than S-corp?
There is no difference in accounting. I would say - the tax preparation might be a little more complex for C-corporation - but in most situations the difference is very small.
Customer: replied 10 months ago.

Lev, thank you very much. That clears up a lot. But to finalize, I am thinking about opening C-corp anyway for different projects and with different partners. So, are you saying that in C-corp owner-employees and non-owner employees are threated the same as far as reimbursement for medical insurance premiums and other medical expenses? Thank you

Expert:  Lev replied 10 months ago.
That is correct - there is no different treatment between shareholder-employees and not shareholder-employees for C-corporations.
C-corporations are completely separate entities and pay their own income taxes - not like S-corporation which are more like partnerships.

What you might want to consider - in order to be eligible for tax favorable treatment - the health insurance plan must satisfy certain Nondiscrimination Provisions - which mainly means - the plan must be the same for ALL employees and may not be in favor of highly
compensated individuals.
That means - all employees - either shareholders or not - must be equally treated by the plan.
For specific requirements - see here - http://www.irs.gov/pub/irs-drop/n-11-01.pdf
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22704
Experience: Taxes, Immigration, Labor Relations
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