What are the rules for including fringe benefits in a business owners paycheck?
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QuickBooks and Year end Fringe Benefits

The tax guy wants me to include the value for benefits in the owners  W2:

 
Are the benefits subject to federal income tax, social security taxes or state income taxes?
 
History
Generally, the premiums paid for accident or health insurance coverage are excluded from non-owner employee's paychecks under Internal Revenue Code Section 106.  This same code section excludes the employees contribution through payroll deductions from taxation if the policy is under a code section 125 cafeteria plan.  
 
Health insurance premiums paid by small businesses that are sole proprietors, partnerships, or S Corps on behalf of the owners, are NOT deductible by the business.  Yet the amount of the inclusion is generally fully deductible on page 1 of the 1040 return under code section 162 (1).  

S Corporation will get a deduction "as wages" is permitted for the value of insurance premiums included in the owners W2 see Publication 15 (circular E p. 13).   Section 61(a) states the 2% or more shareholder is required to include that the value of health insurance benefits in gross income as  wages of S Corporation employees.

So including the health premiums/benefits in the W2, will generate the same net income/loss that passes through to the Shareholders personal 1040. Also, section 162(1) allows for a full deduction of the the included premium in wages, the net effect on the personal 1040 taxes is zero.  The whole process for most is an administrative pain in the butt!
However, there is a possibility that the deduction will not be allowed.  If you fail to include the amounts in the W2, the S Corp will not be allowed a deduction for the premiums paid and taxable income will increase by the disallowed premiums.  No deduction will be allowed on the 1040 unless it was included in the W2.

When is the value included in the W2 not deductible on the 1040?
The deduction on the 1040 is not allowed to the extent that the deduction exceeds earned income  (code section 401 (c)(2)) derived by the taxpayer from the trade or business that is providing the medical coverage, and also the deduction is not allowed for amounts during a month in which the taxpayer is eligible to participate in any subsidized health plan maintained by the spouse of the taxpayer (section 162 (l)(2)(B).

 
Normally, the amounts are included in wages for income tax purposes but are NOT wages subject to Social Security and Medicare taxes if the requirements for exclusion under section 3121(a)(2)(B) are satisfied.  If indeed the requirements for exclusion were not met, there would be an additional tax burden in the form of Social Security and Medicare taxes to both the business and the Shareholder/employee.  We would all like to be sure that the requirements for 3121(a)(2)(B) are satisfied.
 
So, what are their requirements for exclusion?  Remember, we already know that the premiums are included as federal income taxable wages and we know for the most part a deduction against these additional wages will be allowed.
We are determining if they are excluded from Social Security taxes and that is the hard part.   Code section 3121 says the payments must be made under a plan or system for employees and their dependents for a Class or (classes of employees) and their dependents.  Where do we find a definition of what qualifies as a Class of employee?
 
Nondiscrimination rules applicable to self-insured health plans can be found under code section 105(h) and to cafeteria plans under code section 125.   A good overview of Section 105(h) can be found here.  Generally, it states that the plan must be offered to 70% of employees  (excluding employees with under 3 years of service, under age 25, part-time, collectively bargained, and nonresident aliens),  80% must participate, or must be offered to a "fair cross-section" of employees, under the same type of rules applicable to qualified retirement plans.
 
To this day, there is an UNCLEAR definition of what is "self-insurance".   If you have paid an insurance company premiums for coverage, haven't you shifted the risk to them and therefore are not self insured?  This analysis is not supported through the court cases, however,  the rules on how to separate the "insured" from the "non-insured plans" have never been explained. 
 
With all this ambiguity surrounding whether the premiums are subject to Social Security taxes, and coupled with the fact that no one has seen any IRS audits on discrimination of health benefits, I will leave it up to you to make the decision whether to subject these premiums to Social Security taxes
 

QuickBooks Payroll - Including S-Corp Premiums in the W2

Create an Addition payroll item:
1. Lists menu> Payroll Item List >Right Click and select New payroll item
2. Select Custom Setup and click Next
3. Select Addition and click Next
4. In the Name used in paychecks and payroll reports window, enter the name of the new payroll Addition item ("S-Corp In") > Next
5. For the Expense account, enter the account that normally holds the gross wages for S-Corp owners (officer compensation* ) >Next
6. In the Tax tracking type window, select S Corp Pd Med Premium from the drop-down list > Next
7. Click next in the tax window, QuickBooks does a good job of selecting the appropriate taxes.
8. In the Calculate based on quantity window, select Neither > Next
9. In the Default rate and limit window, clear both fields (they should be blank) and click Finish


Create a Deduction payroll item:
1. From the Lists menu > Payroll Item List > Right Click and select New payroll item
2. In the Select setup method window, select Custom Setup > Next
3. Select Deduction > Next
4. In the Name used in paychecks and payroll reports window, enter the name of the new payroll Deduction item ("S-Corp Out") > Next
5. Skip the Agency liability field, in the Liability account (employee-paid) Type S-Corp Health Reclassified> click on the tab on your keyboard and add the new account as an expense account and make it a sub-account of Health Insurance Expense. > Next
6. In the Tax tracking type window, select None > Next
7. In the Taxes window, do not make any selections. > Next
8. In the Calculate based on quantity window, select Neither > Next
9. In the Gross vs. net window, select net pay > Next
10. In the Default rate and limit window, clear both fields (they should be blank) and click Finish

Create a paycheck for each S-Corp owner that is covered by a company health insurance policy.
Use S-Corp payroll items you just set up: This adjustment can be made in a separate paycheck using unscheduled payroll or in the next regular payroll

1. Click into the Review Paycheck
2. In the Other Payroll Items field, select the Addition item created, S-Corp In, from the drop-down list, and then enter the premiums paid for the year in the Rate column
3. On the next line in the Other Payroll Items field, select the new Deduction item you created, S-Corp Out and enter the same amount entered for the Addition item in the Rate column. You will notice that this adjustment will have a calculation for federal and state income tax withholding taxes (that should be it, if there are other taxes withheld, then the payroll item was not setup properly) Change the federal and state income taxes withheld to zero and discuss adding that same amount as additional withholdings on the next regular paycheck. There should be no other taxes deducted.
4. Once the Check Amount is zero, Click OK

* If you have all your payroll items pointing to payroll expenses and payroll liabilities, call us for a QuickBooks support session.  We will quickly customize your QuickBooks so that wages are posted into accounts for each department (sales, admin, warehouse, officers) and more! 

Remember, now is a good time to address including the value of  Fringe benefits provided by the employer in the W2 too!
For a complete list see http://www.irs.gov/pub/irs-pdf/p15b.pdf

Common fringe benefits reportable include
Taxable cost of group term life insurance over $50,000
Nontaxable sick pay
Employee personal use of a company vehicle
Employee discounts over certain limits
Meals
Bonuses
Awards

We have a payroll consulting service plan call and find out more! It really is comforting to a bookkeeper or business owner to have someone to guide them through this maize, the right set-up and training is worth both peace of mind and avoidance of costly penalties.
 


  Give us a call 800-216-0763 to find out about all the support and training programs we offer
in all matters QuickBooks, Payroll and accounting.

 

 
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