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.

Advertisements

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.

Be a Pig (Just Don’t Be a Hog)

My new book, The Pocket Small Business Owner’s Guide to Taxes, is scheduled to be released on 10/9/12!  The book is being published by Allworth Press and I have setup a new website to promote the book at www.BeAPig.com.

The book expands upon the content that I have written for this blog over the years and provides both in-depth and practical information for the small business owner.  The main focus of the book  is maximization of tax deductions, LLC and S corporation tax issues, and the tax and accounting essentials that you should understand.  If you have found the articles on this blog to be helpful, I think you will find this book to be a good resource and reference.

Check out the Be A Pig website to find out more.  You can also pre-order the book if you are interested.

Lastly, if you are on FaceBook, you can like the PDXCPA blog and My Book and stay current on all the latest updates and giveaways.

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.

 

Loans from S-Corporation Shareholders

1120s

If you were to loan me $20k today, would you insist on loan documents, regular payments, and interest?  Of course you would!  Such requirements and documentation would seem to be common sense, so why do many shareholders fail treat the loans to their S-Corporations the same way?

An S-Corporation is a separate legal entity, and any transactions between shareholder and the corporation have to be treated as such.  Any funds contributed by the shareholder are either capital contributions or loans from the shareholder.  If the corporation pays personal expenses for the convenience of the shareholder, the payment has to be reclassified as a loan from shareholder repayment or a distribution.  There needs to be a very clear distinction between shareholder and corporation with these transactions and the documentation should be the same as if the transactions were with an unrelated third-party.

In my experience, I have seen this issue come up in IRS audits and with bank loan renewals and applications – especially with S-Corporations owned by a single shareholder.  Without other shareholders to help keep things formal and a clear separation between business expenses and shareholder personal expenses, the single shareholder can get lazy and end up using their S-Corporation like a personal checking account.  If matched with very poor documentation, this can lead to big problems with the IRS – even loss of the S-election status in serious cases.

How can you avoid these problems and make sure you are properly documenting your shareholder loans?  Here are my suggestions based on my experiences with small S-Corporations:

  • Keep your personal expenditures and transactions out of the S-Corporation.  It is a separate legal entity and there is no reason for co-mingling personal and business transactions except for the occasional payment for the convenience of the shareholder.
  • Reimburse any expenses paid personally on a regular basis via an signed expense report.  Attach receipts and document the who, where, what, and why for meals and entertainment, travel, and other expenses that need explanation as to the business purpose.
  • Avoid using personal credit cards for the business; however, if you must resort to this, try to use the card(s) exclusively for business and then use other personal credit cards for personal transactions.
  • If you loan funds to the S-Corporation, keep a record of the loan and try to have the corporation make regularly scheduled repayments.  If the loan exceeds $10k, the corporation needs to start tracking and paying interest on the loan principal.
  • Talk with your CPA and make sure you understand any reclassification entries made to loans from shareholder accounts.
  • Use a lawyer that specializes in small business that will prepare demand notes and documentation for the loan from shareholder on a regular basis.  Many small S-Corporations try to cut corners in this area and it can really hurt them down the line.
  • Document, document, document!  I know life is busy and small businesses require more time than you have, but do not get behind on this or create excuses for yourself.  If you cannot meet documentation requirements, then you should not be incorporated.

LLC vs. S-Corporation, Round 1

When setting up a business and deciding on entity type, most people are looking for 1) liability protection and 2) tax savings – specifically lowering self-employment tax liability.  For small businesses, the two best options are the LLC or the S-Corporation, and many tax or legal professionals seem to advocate for one team or the other so it is hard to know what entity is truly best for your business.  Well, I am not your advisor and I have been on both teams, so hopefully I can provide you with some balanced information and after a couple rounds, hopefully we will have a winner for your business…

Will the business own appreciating property like real estate?

If your business has anything to do with real estate rentals or owning and managing commercial or residential property, then LLC is the early winner.  This is vitally important – you should never put real estate into a corporation.  If a CPA or tax practitioner recommends this for a new small business, I would consider it malpractice.

Basically, if you put real property into an S-Corporation, then you are going to have a taxable event if you transfer it out of the corporation in the future and you will pay tax based on the fair market value of the property at that time.  I could tell you some horror stories on this issue, but trust me – if you have a residential or commercial property, put it in an LLC.
LLCs are perfect for real estate as you can move the property in and out of the entity without any taxable events.  Plus, they are much easier to setup, administer, and report for tax purposes.  Even better, if you have one owner, you can use the single-member LLC for your real estate and then the tax reporting is simplified so that you only have to complete a Schedule E as part of your personal return.

How many owners will the business have?

This is another important question to look at upfront, as it can result in a knock out in round one.  If you will be the sole owner of the business, then your options are limited to the following:

Single-member LLC (SMLLC)

The only LLC offering for the single-owner business is a great option for easy setup, administration, and tax reporting; however, it is going to cost you in the form of self-employment tax.  To the IRS, The SMLLC is no different than a sole proprietorship – in fact, the SMLLC is reported on Schedule C just like a sole proprietorship.  Unfortunately, this means that you will pay self-employment tax (15.4%) on the entire amount of your net taxable earnings.  This can really add up – especially if you are a consultant with few expenses and/or minimal capital asset needs.  After a few years of paying a hefty tax bill, most business owners are willing to put up with some extra administration and tax prep costs in exchange for a much lower tax bill via use of the S-Corporation while paying themselves a reasonable wage.

S-Corporation

The big winner for single-owner businesses is clearly the S-Corporation as most business owners can end up saving thousands.  With an S-Corporation, you do not pay self-employment tax on the earnings, BUT the owner must pay himself a “reasonable” salary, which means you are paying payroll taxes on the Federal and state level.  Usually, if you sit down with a CPA and lay this all out, they should be able to give you a ballpark of your tax savings each year; however, there are costs related with this:

  • Legal costs – it is not cheap to setup, but I would never suggest a D.I.Y for an S-Corporation.  Get it setup right and avoid legal problems later.
  • Accounting Fees – keeping your accounting data on a spreadsheet may not cut it anymore – especially if you use a lot of credit cards and loans.  Be prepared to pay a bookkeeper or an accountant to get your books setup right so that the tax preparation goes smoothly.
  • Tax Prep fees – S-Corporation returns require much more work and typically range from $750 – $2000 or higher depending on complication.  Plus, you now have to file quarterly payroll tax returns and payroll to process, which can run you about $95/quarter even with one employee using ADP, Paychex, of your CPA.

If your savings are still substantial after factoring in these costs, then you should definitely go with the S-Corporation, but make sure you have a good lawyer and a good CPA that you like as you will be talking to them frequently for the first few years.

Well, round 1 is in the bag and we are tied at 1 a piece.  In round 2 we will deal with issues for businesses with more than owner.

Just remember – never choose an entity for your business without consulting a CPA and lawyer as every situation and business is unique.  Give me a call at 503.224.8844 if you need a CPA or a lawyer to help you with your new business.

S-Corporation Failure to File Penalty

Back in December of 2007, the 110th Congress passed HR4351 or the “AMT Relief Act of 2007”, which was the aftermath of the showdown regarding alternative minimum tax that I posted about at the time.  The bill had a lot of small print regarding new revenue raisers – one in particular: Sec 223 regarding failure to file penalties for S-Corporation returns.

For returns required to be filed after 12/20/07, there is a penalty of $85 per shareholder per month that the IRS can charge ($89 for returns due after 12/31/08).  This means that if you filed your 2007 S-Corporation return after 3/15/08 (or 9/15/08 if extended), then you either have received an IRS penalty notice or will soon enough.  I personally have not seen one of the notices yet as our firm filed everyone timely; however, if you have received one, please let me know.  This is the first round of the notices and strategies have not been tested like with the partnership penalties, so I am curious as to the wording of the letters.

I had a comment on my recent partnership penalty post asking if Rev Proc 84-35 would work for getting S-Corporation penalties abated, and while my immediate answer is “no” since 84-35 pertains particularly to 1065 returns, the concepts behind the Rev Proc may work in your abatement request letter to the IRS, so try using the concept – just do not quote the Rev Proc.  I did read the actual IRS code on the new penalty, and according to IRC Sec 6699(a)(2), if “reasonable cause” can be shown, then they may abate the penalty.  This is usual language with many of the IRS penalties, so this is not much help.  For now, I would write a solid letter outlining the unusual events outside of your control that prevented you from filing by the deadline and emphasize that you are a small S-Corporation with less than 10 or less shareholders and that all shareholder timely filed their returns with their share of S-Corporation income and deductions.  If they deny abatement, try again – there are many, many different employees at the service centers and persistence can pay off.

I will let you know if I hear about any other strategies that emerge as practitioners try their hand at abatement requests with the first round of penalty notices.  If you received a penalty notice, call your CPA or accountant as ignoring these notices will only create more problems.