S Corporation Shareholder Health Insurance – 2013 Update

I wrote about about the reporting of health insurance for more than 2% shareholders last November and provided an excerpt from my book on the subject, but for 2013, this issue is even more crucial because of several tax changes.  As a more than 2% S Corporation shareholder, your total health and dental insurance premiums for the year need to reimbursed (if not paid directly) by the corporation and included on your W-2.  If this is not done correctly, you are technically not allowed to claim the self-employed health insurance deduction on your individual tax return, and instead you have to claim the deduction on Schedule A.  This treatment has never been desirable because of limitations on Schedule A, but for 2013 the limitations have been increased.  First, the medical expenses floor has increased to 10% (up from 7.5%), which means you only get a deduction for the amount of expenses that exceed 10% of your adjusted gross income.  Secondly, the itemized deduction phase-out (Pease limitation) is back for 2013 for higher income taxpayers, so even if your medical expenses exceed the 10% floor, you could encounter further limitation.  Overall, the difference between a self-employed health insurance deduction and a very limited deduction on Schedule A can translate to thousands of dollars in taxes for a shareholder, and all because of a minor reporting error.

Here is what you need to do before year-end:

  • Calculate total health and dental insurance premiums for the year for each >2% shareholder (including premiums that will be paid before year-end).
  • Make sure the premiums have been paid or reimbursed by the S Corporation.
  • If amounts were deducted from a >2% shareholder’s wages for a portion of their health or dental insurance, contact your CPA or tax preparer, as adjustments will need to be made.  These deductions should not have been made, so immediate modifications will need to be made to your payroll processing.
  • Contact your payroll processor to have the total 2013 health/dental insurance amount added to your W-2 BEFORE the last pay date in the calendar year.  Also, have them coordinate with your CPA or tax preparer to make sure it is reported correctly.
  • If you self-prepare payroll through QuickBooks, I recommend this resource for recording the insurance amount properly.

I strongly recommend putting this at the top of your to-do list for December, as it can be very costly to amend W-2s and federal and state payroll tax filings after their due dates.

If you are in the Portland metro area and need assistance with this issue, you can reach me at brian@pandgcpa.com or 503.244.8844.

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Reporting Health Insurance for S Corporation Shareholders

NEW! 2013 Update Post 

The following is an excerpt from my book, The Pocket Small Business Owner’s Guide to Taxes, and is important information for S corporation shareholders as 2012 is starting to wind-down.  This is especially important if you use a payroll processing company, as they will need to include your health & dental insurance on your last payroll run.  This is a time-sensitive matter, and failure to report your premiums correctly can be a very costly mistake.

The reporting of health insurance premiums for a more than 2 percent S corporation shareholder can be a little confusing; however, it is crucial that it is reported correctly if you want to maximize your deduction. If you miss a few simple steps before the end of the year, you could end up limiting or losing your deduction all together.

The self-employed health insurance deduction allows self-employed individuals to deduct their health insurance premiums on the front of the 1040 as an adjustment against income. Even though an S corporation shareholder is not technically self-employed, the IRS requires a more than 2 percent S corporation shareholder to report the deduction as if they were self-employed and not on the S corporation return.

Simple Steps to Maximize Your Deduction

Below are the steps that have to be taken in order to get the self-employed health insurance deduction. Make sure you follow them closely as an error can result in the loss of substantial tax savings.

  • An S corporation cannot deduct health, dental, and other medical premiums for a shareholder who owns more than 2 percent. Their premiums should be tracked separately in the accounting system throughout the year.
  • If the corporation did not pay the premiums during the year, make sure the corporation reimburses them before the end of the year.
  • Before the final payroll run of the year, calculate the total shareholder health, dental, and other medical insurance premiums paid or reimbursed by the corporation as this figure will be needed for the final payroll and the shareholder’s W-2.
  • The amount of premiums for the year is paid to shareholder as payroll, but there is special payroll tax treatment for this payment. The amount is subject to Federal and State withholding, but it is not subject to social security or Medicare tax. If you use a payroll service, they will have a pay item for this specific payment.
  • On the W-2, the amount of the premiums is recorded in box 1 wages, in the state wages, and in box 14 as “S/H Health Ins” or a similar description.
  • Finally, on the shareholder’s individual tax return, make sure the amount of shareholder health insurance is deducted as self-employed health insurance on the front of Form 1040.

The end result is that the payroll payment for the premiums is deducted as a wage on the corporation return, the wage is taxed as income on the individual return, and the self-employed health insurance deduction is taken on the personal return, which all nets out to a deduction in the amount of the premiums. This may seem like a whole lot of unnecessary paperwork, but it is much better than the treatment that results if you do not follow these steps.

Tax Consequences of Incorrect Reporting

If a more than 2 percent shareholder fails to include their health insurance premiums on their W-2, technically the IRS will not allow the self-employed health insurance deduction on the individual return, and the shareholder would have to claim the premiums as a medical expense on Schedule A, which unfortunately is subject to a haircut of 7.5% of adjusted gross income (10% starting in 2013). This means that your deduction is reduced by an amount equal to 7.5% of your adjusted gross income, and if there is anything left then you get a deduction for the remaining amount. If you run the numbers, this is huge loss of deduction and a horrible penalty for not following the IRS rules.

Given the high cost of health insurance premiums these days, it is very important that you make sure and follow the steps listed above each year. Have your tax professional help you and do not wait until tax time as amended W-2s can be costly to prepare.

For more S corporation shareholder tax advice like this, refer to Chapter 9 in my book.

Attention S Corporation and LLC Procrastinators

There is less than a month until the final extended deadline for 2011 S corporation and LLC tax returns, and it is crucial you file on time to avoid late filing penalties.  If you have not sent in your 2011 data to your CPA or tax preparer, you might want to work on it this weekend instead of enjoying the summer weather (or lack thereof if you are in Portland this morning).

I have written numerous posts about the S corporation late filing penalty that can only be abated if you have no prior late filing history, and the partnership penalty that the IRS has recently been making more difficult to abate.  If you have never read up on this topic or had to deal with this issue, please take a few minutes and click on the links above to read about the penalties, as they can amount to thousands of dollars in unnecessary, non-deductible costs for your business.

Even though there are automatic abatement procedures in place for entities taxed as partnerships, you should not assume that if it has worked for you in prior years that it will work in the future.  Last year, the IRS made changes to their internal procedures with regard to how they dealt with late filed partnership returns, and I had many abatements challenged or denied that had been approved in prior years.  You can read about some specific problems on my TaxQueries.com post, but I believe the IRS will continue making it more and more difficult for partnership filers that continue to file late each year.

Make finishing your 2011 accounting work a priority this weekend!  Not only will your tax preparer appreciate it, but not having potential penalties hanging over you is even better.

 

Accounting for Health Insurance Premiums

At this point in the year, many of you are now familiar with the Small Business Health Care Tax Credit.  If you qualified for the credit for 2010, you likely witnessed first hand all the extra information that is required for the credit calculation.  Below is an except from our recent newsletter on the tax credit.

Health Insurance Premium Bookkeeping
Much of the tax credit calculation revolves around eligible employee hours and wages; however, once an employer is determined to be eligible for the credit, much more information is needed with regards to the employer’s health insurance premiums.  Fortunately, a few simple procedural bookkeeping changes can greatly simplify this portion of the calculation:

  • Classification of owner and family member insurance – when posting health and dental insurance premium payments, make sure premiums for owners and their family members are posted to a separate sub-account of employee benefits.  These premiums are not included in the calculation, so it is important that they be separated.
  • Premiums for seasonal workers – even though it is important to classify seasonal worker wages and hours separately from eligible employees, their premiums are actually included in the calculation, so make sure their premiums are included with those for eligible employees.
  • Record coverage information in books – in order to finish the calculation, you have to report the type of coverage (single or family) and the number of employees with each coverage type.  To simplify this final step, be sure to note this information in the “memo” field in your books when recording the premium payment.  Typically, this information is provided on the bill from the insurance company, and it is much easier to record this each month than pull all the bills at year end.

For general information on the Small Business Health Care Tax Credit, refer to our post from last year.

Small Business Health Care Tax Credit

With all the new incentives out there for employers and recent tax law changes, most small business owners are likely feeling a little overwhelmed.  Between the COBRA subsidy, the HIRE act, and the new incentives & changes from the Health Care Reform Act – being an employer has become much more complicated.  In fact, if you are not keeping up on the changes and planning ahead – you could be missing out some credits and incentives that are available to your business.

One of the specific credits from the Health Care Reform Act that requires some current planning in 2010 is the Small Business Health Care Tax Credit, which is a 35% tax credit based on premiums paid to cover employees.  As the name suggests, you have to be a small business – one with fewer than 25 full-time employee equivalents (FTEs).  In addition, you have to pay average annual wages below $50,000 per FTE.  Lastly, as the employer, you have to pay health insurance premiums under a “qualifying arrangement”, which in simple terms means you pay a uniform percentage of not less than 50% of the premium cost of coverage for each enrolled employee.

I probably lost many business owners right there; however, after reading the fine print in the law you may find that you qualify after all.  The most important fine print: wages paid to business owners or their family members are not included in calculating the average wages or the number of employees.  This is very good news for corporations as the shareholder wages would have likely made most ineligible for the credit right off the bat.  This could work out well for small, family-owned businesses that provides health insurance and employs a number of non-family employees.

Then we hit the final hurdle – as an employer, do you pay at least 50% of the premium cost of coverage for all your employees?  Even if you do not pay a full 50% or even provide this employee benefit at all, you should at least run the calculation to see what your potential benefit would be.  It may be worth looking into.  Not only do you get a tax credit, but in this economy, such an employee benefit could be given in lieu of pay increases.

To calculate you potential tax credit, check out the calculator at smallbusinessmajority.org.

More detailed information on the tax credit:
IRS Q&A Page on the Small Business Health Care Tax Credit
White House Summary & Fact Sheet

2009 Year-End Tax Planning – Part 2

Year-End Tax Planning for Small Business Owners

For 2009, there are plenty of year-end tax planning opportunities available to the small business owner.  Some new provisions help businesses that have been dramatically affected by the recession while others help businesses that have had very a profitable year.  Below is a general overview of several of the more important planning opportunities.

Bonus Depreciation:

Many companies used the bonus depreciation provision in 2008; however, due to the current economic conditions, business owners are much more restrained with regard to capital expenditures than in prior years.  Nick Parsons, one of the partners at our firm, recommends concentrating on capital purchases that are needed and will help generate more profit for the business rather than just purchasing for the sake of tax savings.  He also recommends looking at purchases that will need to be made in the next five to six months and accelerating those purchases if possible before year-end.  Even if the business had a poor year, bonus depreciation could produce a tax loss and actual tax refunds with the new net operating loss carryback rules (see below).

Bonus Depreciation details:

  • Only available for NEW property, 20 year class life or less
  • Provision is scheduled to expire after 2009
  • Must be placed in service before year-end

Code Section 179 Depreciation:

Businesses with net taxable income are taking advantage of the new limits on 179 depreciation ($250k), which allow you to write-off the entire cost of the fixed asset within the year of purchase.  However, many businesses are looking at losses this year, so the bonus depreciation can be a better option.  Regardless, using the right mix of bonus and 179 depreciation can create a net operating loss that can be carried back five years under the new rules (see below).

One minor detail to keep in mind – unlike bonus depreciation, the property does not have to be new to qualify for 179 depreciation.

Vehicle Depreciation:

If a business is looking to buy a new vehicle in the next six months, accelerating the purchase before year-end could be very beneficial.  The luxury auto depreciation limits have been increased from $2,960 to $10,960 through 2009 thanks to bonus depreciation rules.  There are different rules for trucks, vans, and SUVs, but for a typical passenger car used more than 50% in business – this provides great tax savings.

Five Year Carryback of Net Operating Losses:

Many businesses affected by the recession have been able to make use of the expanded net operating loss carryback rules for the 2008 tax year, and many received substantial cash refunds that helped them with current cash flow problems.  Now the carryback rules have been extended for 2009 tax losses, which should bring some more immediate help.  However, the rules are a little more complicated this time around:

  • For 2008, the expanded carryback was only applicable to businesses with gross receipts under $15 million.  The net operating loss could be carried back up to five years and there were no further complications.
  • For 2009, the rule is expanded for all businesses, however, there are complications:
    • For businesses under the $15 million gross receipts limit, the 2009 NOL can be carried back up to 5 years even if the 2008 NOL was carried back under the prior rule.  The only difference is that for 2009, you can only use ½ of the taxable income in the fifth year.
    • For businesses over $15 million in gross receipts, they can use the extended NOL carryback for 2008 OR 2009, but not both years.  Also, like with small businesses, they can only use ½ of the taxable income in the fifth year.

Solo 401k Contributions / Profit – Sharing:

For small business owners that had a good year and are looking for tax deductions while putting away for retirement, the solo 401k is an excellent vehicle that many ignore because of the extra reporting requirements.  Small, family-owned businesses often use the SIMPLE IRA plan to put away up to $11,500 ($14,000 age 50 & older) under the 2009 limits.  However, given sufficient self-employment income, the same small business owner can put away up to $49,000 ($54,500 age 50 & older) using a solo 401k plan and also make the same contribution for the business owner’s spouse if they are involved in the business.  The are special requirements for the solo 401k, so it is definitely something you need to speak with a professional about before opening an account.  However, even if the solo 401k is not an option for you, there are other 401k plans that would still save you much more than with a SIMPLE IRA plan.

Update on S-Corporation Failure to File Penalty

I had previously discussed this issue in my 1/22/09 post entitled “S-Corporation Failure to File Penalty”, but there have been so many comments and updates since January that I felt I should post a formal update.  It is an important issue now that the the first few rounds of IRS abatement request responses have been sent out and the fact that we still do not have a Rev Proc similar to 84-35 (automatic abatement for partnerships) issued to address this penalty.

Just to quickly review the basics from the previous post, this penalty is charged to S-Corporations that failed to file their 1120S return timely, which means you either failed to extend your return and filed after the March 15th deadline, or you extended but did not file by the September 15th extended deadline.  Other details of note on the penalty:

  • Begins for returns filed after 12/20/07
  • $85 per shareholder per month late ($89 for returns due after 12/31/08)
  • Applies to any entities taxed as an S-Corporation

I recently sent an abatement letter for a client that used some of the language from Rev Proc 84-35, and even though the IRS abated the penalty, they made a point about the fact that they did not base the decision on any reasoning from 84-35.  In the response letter, the IRS stated that the abatement was ”based solely on the fact that you have a good history of timely filing and timely paying”. They also stated the removal was a “one-time consideration” and that future penalties would only be abated if the information met the “reasonable cause criteria”.

The thrill of getting the penalty abated quickly faded as I realized that this is not good news for S-Corporations if a Rev Proc similar to 84-35 is not forthcoming.  Based on recent reports of plummeting Federal tax revenues, I doubt we will see a Rev Proc anytime soon that would provide automatic abatement for small S-Corporations like we have for partnerships, so I would definitely suggest a few things with regard to requesting abatement of this penalty:

  • If you request abatement of penalties, do not use any language from Rev Proc 84-35 – you are just inviting a short lecture from the IRS.
  • If you have a history of timely filing and paying, state this in the letter as the reasoning for your abatement request along with an apology or two.
  • If you do not have a good history – hopefully you have a sad story of unusual circumstances that will work as reasonable cause.  In my experience, the IRS rarely abates penalties for reasonable cause.

Lastly – in the future, FILE TIMELY!  March 15th is the deadline and if you are not going to be able to file by that date, make sure you call your CPA or accountant to make sure an extension is filed.

If you received a penalty notice and would like assistance in dealing with the IRS, feel free to contact us to find out more about our services.