Discussion:Hot news on S corp Health Insurance (Notice 2008-1)

Murrsg07 said:

http://www.irs.gov/pub/irs-drop/n-08-01.pdf sec 162 deductibility of 2% shareholder-employee ruling to appear Jan. 14, 2008

PVVCPA said:

14 December 2007

No 105 HRA required. Interesting sentence. "A 2-percent shareholder is not an employee for purposes of Sec 106."

I agree, Paul, no mention made of a required written plan, now, so *poof* to 105Concepts and the like, sorry guys. The difficulty is that it requires addition to the W2, which is a huge pain in the keester, esp. since how am I to even know the correct amounts from some of the clients when I'm jamming the W2's out? Ah, well, at least it's written now.

Now maybe we can blow up that other thread, or if we could somehow edit comment #1 to send people to the IRS new position, we could save a lot of eye strain.

Thanks, DT, never even thought about that, but IRS did yield to the law and intent here. It's the right thing. But they're making me do those W2's correctly now, so a victory for them, too!

I suppose now this justifies my fee for figuring out the W-2 inclusion and communicating it to the payroll services.

I'm still thinking it might not be too crazy to go the simple route & have the S corp deduct the wages, and in the event of audit, amend the W-2 to include the health insurance. The payroll services around here are especially dense about this adjustment.

So Pete, thinking out loud, I book insurance expense all year long on the corp books. Now, do I debit officer salary and credit insurance to shift it? Or credit NP-S/H? Hmmmmmm...have to think of this. I know, I know, I should know how to do this, but my W3's have always matched PR reports and P/L's for perfect audit trail. No add-on's. Crud, this affects 941 reporting, too. . .back to school to see how all this should work.

JR1, If the S-Corp is not covering all employees, but only a "class of employees", then I think it would be best to prove that with a written plan identifying what that class is. The IRS may attempt to argue the coverage is arbitrary, thus subject to FICA.

It refers to reconciling forms W-2 lines 2, 3, 5, 7, and 9 of forms W-2 with the year's forms 941. Therefore, essentially only social security and medicare wages and taxes, plus federal income taxes withheld, will have to match between the W-2's and the forms 941.

In fact, in my experience with matching letters from the IRS, this is what they do in terms of matching.

Therefore, I'm thinking that box 1 of the W-3 doesn't have to match with the forms 941. Therefore if the client has filed the four quarterly forms 941 and are having us prepare only the forms W-2, we can go ahead and increase box 1 wages for 2% shareholder health insurance without danger of a matching problem down the road.

Treatment of Medical Insurance for S Corporation Shareholders

As we approach year end I thought it worthwhile to review the rules pertaining to deduction of medical insurance “above the line” by S corporation shareholders (i.e., as a deduction on Form 1040, page 1 before adjusted gross income, rather than a Schedule A medical expense deduction). Please review these rules and take appropriate action with your payroll company prior to the end of the year so that you can take best advantage of the rules.

Background:

For the purposes of applying the rules for deducting fringe benefits, S Corporation shareholders owning more than 2% of the stock in an S corporation have been treated like partners in a partnership. Accordingly the deductibility of medical insurance by most S corporation shareholders has followed partnership rules rather than the rules that pertain to C corporations. Those rules treat S corporation shareholders and partners as self-employed individuals for the purposes of fringe benefit rules. Since 2003 self-employed individuals have been able to deduct 100% of the amounts paid for medical insurance as an adjustment to gross income (“above the line”) on page 1 of Form 1040.

In mid-2007 the IRS threw a scare into many tax practitioners by announcing that in order to qualify for the deduction the medical insurance had to be “in a plan” and the medical insurance had to be in the name of the S corporation in order to qualify for this treatment. This caused problems for many S corporation shareholders, especially those S corps whose only employee was the shareholder. In those cases in the State of Washington group medical insurance plans are not available and the medical insurance is issued in the name of the employee rather than the name of the corporation. Consequently, deductibility of medical insurance premiums in such cases was put into question.

Resolution:

Last week the IRS issued Notice 2008-1 providing guidance as to how to alleviate that problem. ( http://www.irs.gov/pub/irs-drop/n-08-01.pdf ) In short, medical insurance paid under individual medical insurance plans may be deductible “above the line” if the following conditions are met:

1. The corporation must establish a “plan” for the payment of medical insurance premiums on behalf of the shareholder-employee.

2. The corporation must either pay the premiums for the plan, or reimburse the employee-shareholder for the premiums paid after being provided proof of premium payment to the S corp.

3. Premiums so paid or reimbursed on behalf of the shareholder-employee MUST BE ADDED TO W-2 BOX 1 WAGES. These premiums should be EXCLUDED from Box 3 Social Security Wages and Box 5 Medicare Wages (thus they are exempt from FICA taxes completely).

4. On the 1120S for the S corporation, the corporate tax return will include a deduction for wages/compensation paid which includes the medical insurance paid on behalf of the shareholder employee.

5. On the shareholder-employee’s 1040 an above the line deduction will be taken for the medical insurance paid by the corporation which were added to the W-2. In Notice 2008-1 the IRS states that if this treatment is not followed, the medical insurance deduction “above the line” will be disallowed and the deduction will be moved to Schedule A. If this happens, the value of the deduction is generally severely limited due to the 7.5% threshold that must be exceeded before medical expenses are allowed.

ACTION ITEMS YOU MUST TAKE TO TAKE ADVANTAGE OF THIS DEDUCTION:

1. Document the existence of your corporation’s “plan” by making note of it in your annual minutes.

2. If you have paid the medical insurance individually, gather up all of your medical insurance payments for 2007 and submit a reimbursement to your corporation to reimburse yourself for those amounts. Post the reimbursement check to “Officer Wages” or similar gross pay expense account.

3. Contact your payroll company to provide them with the information necessary to include the medical insurance expense (directly paid by the corporation or reimbursed to the shareholder) in your final paycheck and your W-2 for 2007.

Please call me if you have any questions regarding this memo.

Thanks, good information.

Now, regarding FICA/Medicare, we ran into the problem last year that several of our clients had no other wages for the year except for the health insurance reimbursements. Our tax program for the first time was disallowing the above the line deduction for these because no FICA/Medicare was withheld on them. We researched this and found somewhere, I can't remember where, that the IRS was requiring that health insurance premiums could only be deducted above the line if there was at least that amount of wages subject to FICA and Medicare. Does anyone else have this issue and if so what are you doing about it?

Upon further review (& research), My post above is incorrect. Please disregard.

The IRS cannot void this deduction because you did not do it the right way. That would be like the IRS voiding your ability to take a Rent deduction because the taxpayer claimed the amount on the Taxes and Licenses line.

If the tax return is still in statute and the IRS auditor is being unreasonable, then you can fix this whole mess by filing a W-2c, amending the 1120S, and amending the 1040. But, I just don't see how the IRS is going to make you walk through these mechanics if it gets the taxpayer right back where he was before.

Got this from CCH. No deduction is allowed in excess of an individual's earned income within the meaning of Sec. 401(C) derived from the trade or business with respect to which the plan providing the health insurance is established.

Nowhere in this Notice does it say that putting the SEHI on the W-2 is a requirement for establishing a "plan". The only requirement of the "plan" is to make sure that payments or reimbursements follow Rev Rul 61-146.

We were always required to put the SEHI on the W-2. This Notice restates what we already knew.

Regarding the state, the starting point for Illinois is AGI, so the wages are the same for federal and state, and they get the advantage of the health insurance premium deduction.

LSC, it sounds like your clients have net income from their corps but are not taking salary. Why not just increase their salaries so there is no issue of FICA/medicare on health insurance?

IRC section 162(l)(5)(A)relating to SEHI states "for purposes of this subsection, such individual's wages (as defined in section 3121) from the S corporation shall be treated as such individual's earned income (within the meaning of section 401(c)(1))"

IRC 3121(a), which is part of Chapter 21 Federal Insurance Contribution Act, defines wages -"For purposes of this chapter, the term “wages” means all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash; except that such term shall not include" — & goes on to exclude various tax exempt fringe benefits.

So, since the definition of S corp income for SEHI deduction purposes refers to the definition of FICA wages, you would have to conclude that you need FICA wages in order to deduct SEHI for S corp shareholders. (Although the IRS requiring you to report the SEHI as wages on form W-2 would sure point toward them falling under the definition of wages even though they are not subject to FICA.)

Clearly income passing through to the shareholder on the K-1 doesn't affect the SEHI deduction.

This is the first time I've thought about the issue, but it appears as though you are 100% wrong & that S corp profit or loss on the K-1 has no impact on SEHI. Perhaps the impact of the K-1 was related to Sec 179.

Lacerte doesn't seem to be handling this yet. Enter wages, SEHI, S corp income, and deduction is not allowed w/ diagnostic saying that the deduction is disallowed due to lack of SE income.

Jessica - That was me. Sorry, I just added my signature.

IRS has just released a major change in how S corp owners are to treat health insurance in order to retain the deduction.

First off, the corp must either pay, or reimburse the owner for, the insurance premiums.

Second, that amount that is paid or reimbursed MUST be added to box 1 wages on the owner's W2. It does not affect withholding or SS/Medicare wages or taxes. It's merely included in box 1 wages. (On the corp's books, we'll credit the insurance account and debit the officer salary, so it's merely reclassified.)

IF those two rules are followed, we are then allowed to deduct the insurance on page 1 of the 1040 as we always had been. If these two procedures are not followed, IRS can disallow the health insurance deduction entirely. Not a good option.

For those with payroll services, advise them immediately so that this is included in 4th Qtr and year end payroll filings.

David, I remember reading a thread about a month ago that included this discussion. I tried to search for it just now, also. I browsed thru about 10 threads and then I got bored.

dated back to 2005-2006 and it was way too long. That's where I posted the IRS link on 12/13. JR1 thought appropriate to start a fresh thread the following day.

I agree with some of the other posters, getting payroll companies to just add it to the W-2 is not a conversation I am looking forward to.

RBT, I have done it that way in the past. Probably not optimal and I will probably not do it that way again. But if it is properly classified as comp on the S corp and properly included "above the line" I cannot see how too much fuss could be made of it in the past. In the future, now that 2008-01 exists, I will try to comply to what the IRS wants. Who wants to pick an unnessary fight?

In 2006 Lacerte: Screen 20.2, Schedule K-1 Information. Part II: Name or number of W-2 received by greater than 2% shareholder. And....The wages entered in Screen 10, Wages must also include the entry in "other information section": "More Than a 2% Shareholder in an S corporation" (Screen 10, code 26).

It was deducted by the S corp, and the individual would include it on page 1 of its 1040 under "OTher Income" (line 21 I think) and would deduct as an adjustment to AGI (self employed health insurance deduction)!! What do you guys think? There is really no effect on the individual since what he is including in other income, he is deducting as an adjustment to AGI!!!! the only benefit is that he getting less pass through income from the S corp?? Does that make any sense?

At a recent Gearup seminar, the speaker said that the IRS will be looking at all entries on the "Other Income" line of page 1 of form 1040 to make sure that it's not income which should be subjected to SE tax.

So, your old cpa firm's method may now be a little risky in terms of unnecessary IRS scrutiny.

In the case of my old cpa firm, even with IRS scrutiny, the amount is still not subject to SE tax, right?

With a C corp, the corp can pay the shareholder's health insurance premiums without having the shareholder including it income, right?

In my opinion you would need to contact the firm that issued the W-2 form to receive a blow by blow description that will set you straight.

Why can't the accounting profession simply convince the IRS to provide an adjustment line on the 941 for SEHI as well as to provide a vehicle on the W-2 to explain this anomaly?

Mike Dubin CPA

What sounds like a good idea regarding the 941 would be for such a small number of filers....we are talking about those S Corps with greater than 2% shareholders. In time I suspect there will be a mirror to Block 12, where items exempt from FICA/Medicate appear, but this time with items included in Block 1 but not elsewhere.

Maybe the best idea is to standardize the ADP W-2 form with its explanation block.

If someone is bringing you a W-2 with SEHI premiums added to their taxable wages because they are an S-corp 2% shareholder, they should also be providing you a K-1 from their corporation. The K-1 is where we should be looking for the SEHI premium, not the W-2.

Mike Dubin Cpa

By including the > 2% SH HI, the Total Payments on the 940 would equal the Total Wages, Tips and Compensation on the 941, as well as box 1 on the W-3. Seems to me no tax difference, but what do you folks think the "correct" way is for 940 reporting when the > 2% SH HI has been added to the 941 and W-2s ?

I think one of the reasons the 940 was changed was so that the total wages could be tied out.

My question deals with the great state of Califonia - QuickBooks ISN"T including the insurance as wages (and we know QB is always correct, right ! ). Intial perusal of Calif ER's guide hasn't provided an answer. I'm headed to the EDD website next, but thought I'd see if any of you fellow Califonia folks have the answer yet. Thanks.

I was never directed through the process of filling out my profile. I've just logged in asked a few questions on occassion. Where do I go to fill out the "profile"? Like others, just trying to get some hlepful information, didn't realize I was being noncompliant.

Side note, I fully appreciate a little thought of benefit to including this on the W2: increased officer salary! Diminishes audit risk perhaps? I had one where the health insur. for his family is 1/3 of his usual pay!

JR1 - I've done some "overriding" myself with QB (hence my snide comment about QB doesn't MAKE mistakes)...what version are you using?

You might try the PR setup so you don't have to do as many overrides.

Oh wait, the one I futzed with was actually QB 2007 (one client uses it, while I use 2006 for all my payrolls). I find it hard to believe QB 2007 does the CA W2 wrong, and QB 2006 will do it right, but I'll know shortly.

I have a trial version of 2008; but tax season is looming too close to want to switch anything I don't absolutely have to - and I'd already signed up with CFS to efile W-2's & 1099's.

Opinions are appreciated.

Thanks.

Does anyone have a theory on why the IRS has become so pushy about this issue?

Scenario- spouse is retired, has health insurance from former employer as retiree, wife is sole shareholder of S-Corp, receives W-2 from S-Corp, has Biz Plan policy for S-Corp with her as employee,  S Corp pays monthly health insurance premium, does she qualify to take above the line deduction for self-employed health insurance under Notice 2008-1

Any response appreciated.

In addition, this is directly from the IRS.gov website: What is Earned Income?

Earned income includes all the taxable income and wages you get from working.

There are two ways to get earned income:

You work for someone who pays you

                or

You work in a business you own.

Based on that, it appears to me that all amounts shown in Box 1 of the W2 are included a earned income.

How about withholding? I have a few payroll engagements, and use an after-the-fact payroll company software. I will call and see how I can put the HI premiums in taxable compensation, without extra tax withholding generated. Obviously this amount should not be withheld on since it gets wiped out by the above-the-line SEHI deduction.

What is wrong with the IRS, that is, requiring that the premiums be included in the W-2 Box 1? Especially with single shareholder S corporations. Apparently the lament of a lot of us. But as with others, I am tickled pink that the premiums on an individual plan can be paid for by the corporation!

The individual paid the health insurance directly, and the premiums were not included in wages.

I would imagine there would be a grace period that extends into January. If so, I would have the corp cut a check rather than making a journal entry.

Thank you

If I include the premiums for the SEP-IRA, and in audit find they should NOT have been included, then I have overfunded his IRA. And if I DON'T include the premiums in calculating his IRA, and I should have, then I will have put a lesser percentage in his SEP-IRA than the other employees.

Please let me know if you think I am missing something. Thanks.

So I spent several hours researching this stuff last night and I just had a question pop into my mind and I don't recall if I read anything specifically relating to this yet (forgive me if it's already been addressed here but I'm not reading through this whole thread again): I have a client who pays for his HI personally, not through S-Corp. He does not submit for reimbursement either. Are we still allowed to take that deduction on line 29 on the 1040 or does this new ruling now prohibit us from doing that unless it's grossed up in wages first? Is this forcing us to put it on the Sch A otherwise?

Why didn't you know?

FWIW.

My clients (husband/wife S corp) did not receive any wages in '07 except for the health insurance premiums, which cover both of them plus their children, so they've never filed a 941 (nothing to amend). Is it too late to file a 941 and throw all the premiums in the 4th quarter - and is it really worth the effort? I haven't issued the W-2 yet. One more thing, he's a shareholder but NOT an employee; she's a shareholder and an employee. The plan is under his name. Does he get a W-2? My eyes are crossed and my brain is loopy from reading what has to be one of the longest running threads ever. Any help would be fabulous.

Sometimes I overthink things. In reference to my advice above, it will certainly get you to the proper place, but today having to address the situation for a client who did not put it into the W-2, I read the following from Notice 2008-1:

"In order for the 2-pecent shareholder-employee to deduct the amount of the accident and health insurance premiums, the S corporation must report the accident and health insurance premiums paid or reimbursed as wages on the 2-percent shareholder-employee’s Form W-2 in that same year. In addition, the shareholder must report the premium payments or reimbursements from the S corporation as gross income on his or her Form 1040, U.S. Individual Income Tax Return."

So, don't make the decision not to comply yourself, advise the client (in writing) that you have done the 1120S and 1040 correctly but that the W-2 and 941 should be amended. If the client makes the decision not to amend, it will be the client's risk, not yours.

"In order for the 2-percent shareholder-employee to deduct the amount of the accident and health insurance premiums, the S corporation must report the accident and health insurance premiums paid or reimbursed as wages on the 2-percent shareholder-employee’s Form W-2 ...."

Question: if the 2%+ doesn't want to deduct the HI on their personal 1040? Does the S corp still have to add it on the W-2?

Here's the ugly story. - MA requires HI - Plan is set up as group plan through local Chamber of commerce in S-corp name - 1 person S-Corp and owner is only employee. The S-corp gets $$ from the State to subsidize the HI (S-corp pays ER 1/2, State pays EE 1/2) - S-corp generates owners income (very low, & only income for family). - S-Corp showed a lost in '07.

Problem: Owner feels if he adds the ER portion to his income, via the w2 'HI-compensation', he will loose his low income subsidized status and then not be able to afford the HI. His other medical expenses are well above the 7% even without the HI cost and the 2%'s income is low enough to pay no taxes. Owner can't seem to see the logic in the S-corp deducting the ER HI as 'compensation expense' and then deducting it again, on his personal taxes. He feels it's double dipping and feels it should be deducted once, as 'health benefits expense' on the s-corp end.

Not sure if the 'subsidized' payments make any difference (no 1099)? Also I need a logical explanation for the 'double dipping.' Care to give me advise on this (if I didn't make it too complicated) Thanks

One issue that I'm not sure of is the effective date of 2008-1, and to what extent it is retroactive. For example, if the employee paid for his health insurance at the beginning of 2007, can he receive reimbursement for insurance payments made at any time in 2007 or is 2008-1 only effective beginning in 2008?

My client, who is the only employee of the SCorp is proposing calling payments previously reported as salary on his 941 & W2 in 2007 as now being reimbursements of med. insurance, and having me amend the 941 & W2 accordingly. If the proper accounting treatment for the reimbursement is to debit officer wages, then the accounting entries remain the same and box 1 on his W2 would be the same. But this would enable him to take the deduction on line 29, and thereby not pay FIT on the insurance payments. I thought the intent of 2008-1 was to reduce FICA & Medicare, not FIT.

Also, there seems to be a conflict between 2008-1 and the instructions supporting line 29 in pub 502, which still specifies that the insurance policy must be set up in the name of the SCorp in order to be included on line 29.

The "double dipping" didn't sound right to me at first either, and it still takes me a minute or so to get it straight in my head when talking about it. The S-corp deducts HI, then the net income flows to the 2%+ via K-1; the HI that was deducted by the S-corp is then showing up again as wages on line 7. So essentially it's not really deducted - just "moved". Then the above the line adjustment takes it off again. As for whether the client is required to deduct it at all, that I don't know. Seems to me that a rule is a rule and HI must be included in wages. To me that means regardless of whether you choose to deduct it, it's still taxable compensation.

What does the state look at to determine low income status? W-2 wages or AGI?

Go ahead and argue with me regarding its not technically correct..already know that...but IF it doesnt get to the W2...doesn't this effectively accomplish the same thing?

So the "new" rules don't change anything except maybe overrule the stupid Headliners from last year and other misdirected IRS inplications and clarify what was always in the instructions.

tp

Anyone see a problem with this.

Congratulations on the test Greg. What payroll software company are you working with, BTW?