2% S Corp Shareholder Health Insurance

[Bees Knees]

Trick question (because I already know the answer…)

New Client – S corporation and 1040 returns

Client already filed payroll tax returns, W-2s, W-3, etc. Wants me to prepare the 1120S and the 1040.

The S corp paid the health insurance for the more than 2% shareholder. The tax preparer last year did not tell the client to add that amount to the W-2 and take a deduction on the front of the 1040. The W-2 for this year has already been filed with Social Security without adding the health insurance to box 1 wages on the W-2.

What should I do?

1. Ignore the rules. Tell the client to do it right next year. It’s a wash anyway regardless of how it is reported so it does not matter. If audited, argue with the auditor that even if it was done correctly, it still would not change the tax on the 1040.

2. Add the insurance to line 7 of the 1120S, officer compensation, and to line 7 of the 1040, wages, and then take a deduction for the self-employed health insurance deduction on line 29 of the 1040, even though this will not reconcile with the W-2 and W-3 filed with Social Security.

3. Separately state the health insurance on line 12d of the 1120S Schedules K and K-1. Report the W-2 income on line 7 of the 1040, report the health insurance on line 21 of the 1040, and take the self-employed health insurance deduction on line 29 of the 1040.

4. Something else...

[BHoffman]

I'll vote for #4. Maybe

Perhaps the health insurance paid under these circumstances is a distribution to the shareholder.

If so, I think the shareholder would have to report the health insurance on his Sch A.

There would need to be some sort of "due to/due from shareholder" offset to even out the distributions if more than one shareholder is involved. It's unlikely that the premium amounts would be exactly in the ownership percentages.

[Lion]

#1

I had a similar case and in the interest of time, and because the only shareholders were husband and wife filing MFJ, I did #1. They have a payroll company. (For other issues, 4Q and year-end reports and W-2s were redone multiple times; so there was no way client was going to pay for and wait for one more redo from payroll that didn't touch any other employees except himself.) For 2008, payroll was handled correctly; for whatever reason for 2009, the health premiums were omitted from husband's W-2. Another preparer does the 1040, but we talk -- with the client present and a part of the conversation -- on speaker phone, so I knew there would be no double-dipping. I took the deduction on the 1120-S and told the 1040 preparer to not take an adjustment, that client already had the tax benefit by not having premiums added to wages. I now have a good contact at the payroll company per my client and will make sure 2010 gets reported correctly.

[WhiteOleander]

Trick question (because I already know the answer…)

New Client – S corporation and 1040 returns

Client already filed payroll tax returns, W-2s, W-3, etc. Wants me to prepare the 1120S and the 1040.

The S corp paid the health insurance for the more than 2% shareholder. The tax preparer last year did not tell the client to add that amount to the W-2 and take a deduction on the front of the 1040. The W-2 for this year has already been filed with Social Security without adding the health insurance to box 1 wages on the W-2.

What should I do?

1. Ignore the rules. Tell the client to do it right next year. It’s a wash anyway regardless of how it is reported so it does not matter. If audited, argue with the auditor that even if it was done correctly, it still would not change the tax on the 1040.

2. Add the insurance to line 7 of the 1120S, officer compensation, and to line 7 of the 1040, wages, and then take a deduction for the self-employed health insurance deduction on line 29 of the 1040, even though this will not reconcile with the W-2 and W-3 filed with Social Security.

3. Separately state the health insurance on line 12d of the 1120S Schedules K and K-1. Report the W-2 income on line 7 of the 1040, report the health insurance on line 21 of the 1040, and take the self-employed health insurance deduction on line 29 of the 1040.

4. Something else...

What we did was show the insurance paid by the s-corp as a distribution. Then show the premiums on the K-1. Tell s/h he is only able to deduct premiums in Sch A.

[Gretel]

Before the preparer penalties came along I would have voted for #1.

In the current climate, it's #4 with the suggestions from the other posters.

[ChEAr$]

Since W2 is already filed, I would outline two choices to the client. After all, it is
his decision.

1. Correct W2's and continue to march and all is right with the world.

2. If he decides against that, treat the insurance payments simply as distributions and he can deduct on schedule a. However advise him the possible consequences of increased 7 1/2 % floor in this event.

[geekgirldany]

I've had around five this year that did not have it on their W-2. So I actually corrected the W-2, W-3, 4th Qtr 941, 940, State W/H form, and SUTA. I don't really offer them another way.

New client's CPA had been doing #2 (yes I know how that sound ) for years and never had any problems. But this year I corrected their W-2s.

Rest of my clients did not get back with me in January about their year end payroll reports. Left messages "don't do 4th qtr payroll forms.... you have to report health insurance". I was ignored. So they ended up paying me to do the correct the forms.

[Bees Knees]

The correct answer of course is #4 - correct the W-2 and take the self-employed health insurance deduction.

The incorrect method that I used is #1. And I am very good at arguing with auditors and winning.

The reason it should not be treated as a distribution and deducted on Schedule A is because it clearly IS compensation under the law to the shareholder, and it clearly IS deductible under the self-employed health insurance deduction rules. Reporting it wrong on the W-2 does not change either of those two facts.

That is why choosing number 1, although wrong, is still correct, since the outcome under the law is still the same. Auditors only care about making adjustments that change the tax. They don't care where or how it is reported, as long as correct tax is paid, and choosing number 1 will give you the correct tax.

[Bees Knees]

Before the preparer penalties came along I would have voted for #1.

In the current climate, it's #4 with the suggestions from the other posters.

Good point, except preparer penalties are based on causing your client to under pay the tax. If the correct tax is paid, there is no underpayment to base the penalty on.

#1 will give you the correct tax. Thus, there can be no preparer penalty.

[Lion]

Late

Considering a corp is already late, you can put the individual on extension and correct the payroll in the off season, amend the corp, and file the individual. If you have more than one shareholder, you should consider that remedy unless he refuses to correct payroll. (Mine was a husband 95%/wife 5% who file MFJ with only husband on health plan, all other employees waived due to better coverage via their own spouses.)

I'd considered the distribution route, remembering using it to deal with something in a partnership. But, it's not the way to treat medical in a corp. And, my client was too high income to benefit from Schedule A 7.5%; so a benefit that he deserved if it had been handled correctly was going to be lost.

I went with #1 because the net was right for both the S and the individual. If I have to redo in the off season, I'll charge him since he failed to give Paychex his medical number (but did give them his Simple number, go figure!). But as Bees says, the bottom line won't change on either return, so I don't see amendments.

[WhiteOleander]

The correct answer of course is #4 - correct the W-2 and take the self-employed health insurance deduction.

The incorrect method that I used is #1. And I am very good at arguing with auditors and winning.

The reason it should not be treated as a distribution and deducted on Schedule A is because it clearly IS compensation under the law to the shareholder, and it clearly IS deductible under the self-employed health insurance deduction rules. Reporting it wrong on the W-2 does not change either of those two facts.

That is why choosing number 1, although wrong, is still correct, since the outcome under the law is still the same. Auditors only care about making adjustments that change the tax. They don't care where or how it is reported, as long as correct tax is paid, and choosing number 1 will give you the correct tax.

If the s-corp doesn't take the deduction for the insurance, isn't the shareholder paying tax on the premiums by way of the profit/loss passed out through the K-1? Since the premiums only go into box 1 and not 3 and 5, there is no FICA issue involved. ???

[RitaB]

Right, but

If the s-corp doesn't take the deduction for the insurance, isn't the shareholder paying tax on the premiums by way of the profit/loss passed out through the K-1? Since the premiums only go into box 1 and not 3 and 5, there is no FICA issue involved. ???

Yes, it flows through to the shareholder on the K-1 this way, but if the premiums had been handled correctly, they would have been in box 1 of W-2. So, now it is on line 17 instead of line 7 of 1040. Net result is the same.

Correct, no FICA issue.

[Snaggletooth]

Complexities

What you have just discussed is a perfect example of something that could be changed, virtually revenue-neutral, to simplify the tax code.

Other examples abound. Some of them involve so little revenue or loss thereof that the govt would spend more money in administration of the law than any revenue recovery or loss.

When is the last time you used Schedule R - Credit for the Elderly? That thing became obsolete when the minimum SS benefits exceeded $5000. What about the throwback to the pre-1970 income on a trust distribution?

I believe preparers like ourselves can support a huge streamlining in the law, and IRS and Treasury people would agree with us. The problem is much of this is legislation and would require further legislation to change it. Getting legislation through Congress is major, unless you are a lobbyist.