When choosing a legal structure for their business, business owners typically consider their tax situation first and foremost. Many smaller businesses elect to organize as an S-Corporation (S-Corp) because it enables the business to “pass through” the company’s taxable income or losses directly to the business owners. This eliminates the disadvantage of double taxation that occurs in a C-Corporation in which profits are taxed first to the business, and then, if distributed to the owners, taxed again at the personal rate. However, the rules for deducting expenses such as health insurance and other benefits are somewhat more complicated for S-Corps, which can put business owners at odds with the IRS is they aren’t handled correctly. The last thing a business owner needs to do is irritate the IRS.
Health Insurance – Deduct with Care
A perfect example of how the tax code can be especially vexing for S-Corp business owners is with the deductibility of health insurance premiums. While deducting health insurance premiums for employees of an S-Corp is straightforward, the IRS has instituted some fairly convoluted rules for the shareholders, who are typically the owners and their family members. At issue is whether or not premiums paid to shareholders are 100 percent deductible. All of these rules apply to any shareholder who owns at least a 2 percent stake in the business.
The first wrinkle in the deductibility of premiums is in the way they are reported. Health insurance premiums paid by the business on behalf of 2 percent shareholders must first be reported as income. That makes it a deductible expense to the business. The shareholder must then report it as income while, at the same time, deducts the expense which offsets the reported income.
If a shareholder, or any family member has access to any other subsidized health insurance plan (i.e. through another employer), the premiums may not be 100 percent deductible. Additionally, the premiums are only deductible as an offset to the amount of income received from the company. It’s not uncommon for a fledging business to generate income for shareholders that is less than the annual premiums paid by the business. So, if the income received by a shareholder is $10,000, but the premiums paid are $12,000, only $10,000 is deductible.
To be deductible, premium payments should be made by the business, or, if paid by the shareholder, there has to be some proof that the premium was reimbursed by the business.
Retirement Plan Deductions More Straightforward
An S-Corp can establish a qualified retirement plan like any other business and make deductible contributions on behalf of its employees. Deductible contributions can also be made for 2 percent shareholders who are also employees of the business. The only concern for the business is that it strictly follows ERISA guidelines for the type of plan it uses.
Other Employee Benefits
Most other work-related benefits, such as education reimbursements and company-paid cars, are also considered deductible expenses and not taxed as income to employees.
S-Corp businesses have many of the same opportunities as C-Corp businesses to optimize their profits through proper tax planning with the advantage of pass through income and deductions for the business owners. However, the tax-treatment of S-Corps is a little more complicated and, due to the continuing clarification of requirements by the IRS, it comes under more glaring scrutiny. So, S-Corp owners are advised to seek the guidance of a tax professional experienced in S-Corp taxation when planning and filing their taxes.
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