Explain it to me like I'm a 4 year old...Health insur for 2% owner

[Penelope]

I understand (I think) how to handle health insurance paid by S Corp for 2% shareholder: The S corp can deduct it, but it must be added to the shareholder's W-2; then it can be deducted on page 1 of the shareholder's 1040. This accomplishes what and for whom? (I know enough not to ask Why.)

Thanks for any clarification.

[Brad Imsdahl]

Health insurance is deductible on Schedule A, but because of the 7.5% AGI limitation, most if not all of the cost would be non-deductible. That means unless it is an employer provided fringe benefit, the taxpayer is paying the cost of health insurance in most cases with after tax dollars.

If an employer pays the health insurance for the employee, the amount paid by the employer is deductible as a form of compensation to the employee, however, the employee is not subject to tax on the compensation as the code says it is a tax free fringe benefit. In other words, the cost of the health insurance is paid with pre-tax dollars.

With a more than 2% S corp shareholder, the amount paid by the employer is again deductible as a form of compensation, however, the employee is subject to tax on the compensation. That would normally make it an after tax cost, but because the 2% shareholder is then allowed an above the line deduction on Form 1040 for the cost of health insurance, that means the cost of the health insurance is paid with pre-tax dollars.

It would be more logical for the government to just simply treat health insurance as a tax free fringe benefit for the 2% shareholder, rather than having to add it back to the W-2 and then deduct it on the front of the 1040, but that is another story.

[Penelope]

Thank you.

Brad, Thank you. I couldn't agree more with the statement in your final paragraph --

"t would be more logical for the government to just simply treat health insurance as a tax free fringe benefit for the 2% shareholder."

[rosieea]

With a more than 2% S corp shareholder, the amount paid by the employer is again deductible as a form of compensation, however, the employee is subject to tax on the compensation. That would normally make it an after tax cost, but because the 2% shareholder is then allowed an above the line deduction on Form 1040 for the cost of health insurance, that means the cost of the health insurance is paid with pre-tax dollars.

It would be more logical for the government to just simply treat health insurance as a tax free fringe benefit for the 2% shareholder, rather than having to add it back to the W-2 and then deduct it on the front of the 1040, but that is another story.

Are there any recent developments regarding the General Counsel memo which indicated that the health policy must be in the name of the S Corporation in order for the shareholder to take an above-the-line deduction?

[Brad Imsdahl]

Are there any recent developments regarding the General Counsel memo which indicated that the health policy must be in the name of the S Corporation in order for the shareholder to take an above-the-line deduction?

Nothing since the IRS headliner from last May. I attended a Bob Jennings Seminar recently and he talked about setting up an HRA (health reimbursement arrangement) where the S corp shareholder has the policy in his or her personal name, and then the S corp reimburses for the cost of insurance. The reimbursement would be added back to the W-2, but it should then qualify for the Self employed health insurance deduction on the front of the 1040.

Bob also said another option is to ignore the IRS headliner, as it has no authority behind it, other than the fact that it is the position the IRS will take if someone wants to bring the issue to court. I would advise everyone who can’t get a group policy to switch over to an HRA. The only negative to an HRA is you have to reimburse all employees, but since we are talking about a single person plan that can’t get group insurance, the HRA having to reimburse all employees would be a non-issue. I know I’m certainly not going to go back and amend anyone’s tax return over this. I think this issue could see some new guidance coming soon, as practitioners are all in an uproar over this. IRS needs to re-think this one.

[JoshinNC]

What about the 941?

Is the amount of health insurance paid for the more than 2% shareholder throughout the year included as compensation on the Q4 941? Up until this point none of my shareholder's health insurance has been included as compensation on Q1 - Q3. If this is not included the W-3 and the sum total of the 941's would not match.

[OldJack]

941

Health insurance benefit for a 2% shareholder is an "added" to W2 (box 1) and not subject to payroll taxes so it is not required to be reported on the 941, but the amount should be noted in box 14 so the shareholder knows how much to deduct on the 1040. However, you could report it on the 941 and show it as exempt from payroll taxes.

[rosieea]

Health insurance benefit for a 2% shareholder is an "added" to W2 (box 1) and not subject to payroll taxes so it is not required to be reported on the 941, but the amount should be noted in box 14 so the shareholder knows how much to deduct on the 1040. However, you could report it on the 941 and show it as exempt from payroll taxes.

I think it needs to be reported on the 941. If not, there will be a mis-match between 941 reporting and W-3 and W-2 totals, and you'll have to waste a lot of time answering letters.

[Bird Legs]

Reported on W-2

In box 1, only, Subject to withholding. Not included in Box 3 nor Box 5.
Not subject to FICA nor M/C.
It is reported on form 941 as Wages subject to income tax only.
Form 941 has a line for Wages subject to income tax.
Another line for wages subject to Social Security tax.
A third line for wages subject to M/C.
If reported properly, the 941's will balance with the W-2s and W-3.

[JoshinNC]

Thanks Bird

I appreciate that clarification!

Will save a lot of time next summer that could be spent on the links!

[KJ Judd]

Can you do a HRA with a high deductible plan & HSA?

And is there any specific or required wording for the HRA? Or generally that the company is going to reimburse medical perhaps subject to certain limits.

Finally, can you elect to do HRA only for full-time employees and not part-time? That might make this more attractive for some of my clients.

Thanks!

[Brad Imsdahl]

Can you do a HRA with a high deductible plan & HSA?

TTB, page 13-30, "Employers can provide employees with high deductible health plan coverage and contribute to an HSA on behalf of an employee and exclude the value of the benefits from taxable wages."

The problem with trying to combine an HSA with an HRA is the HRA is designed to reimburse the employee for medical expenses, including the health insurance premiums, up to a specified dollar amount. For self only coverage in 2007, the HSA requires that the minimum annual deductible of the health plan be at least $1,100. An HRA would contradict and HSA in that the HRA requires the employee to be allowed 100% reimbursement up to the first X amount of dollars, depending on what the employer has set up. An HRA is sort of the opposite of the type of insurance required under an HSA. HRAs cover the first so many dollars. High deductible insurance required under an HSA covers the excess costs after using up the deductible. So I would say no, you cannot combine and HRA and an HSA because an HRA cannot meet the high deductible health plan requirements of an HSA.

The other rule it contradicts is the requirement that you cannot have any other health coverage. An HRA in my opinion is another health coverage plan. So having the high deductible plan under the HSA and the health coverage under the HRA would be two plans, something the HSA rules say you cannot do.

[KJ Judd]

Thanks for the explanation Brad. I have one shareholder S corps with high deductible plans with HSAs. I'm concerned about the exposure, but don't agree with the IRS view. I was hoping maybe HRA would be the answer.