Can our S Corporation pay for our daughters' health insurance?

August 15, 2011

From:  Barb
Date:  Wed, 16 Jun 2010

My husband and I are shareholders in an S corporation. We have three daughters and one daughter-in-law working for us. My husband and I do not have health insurance through the S corporation. Two of our daughters and our daughter-in-law are considering getting health insurance through the S corp. The S corp will pay part of the premium and the employee will pay the balance.

Can they be included in the Section 125 plan for the employee-paid portion of the health insurance?

Since the shareholders don't have a health insurance policy through the S corporation, does the portion the company pays need to go on the W-2 as S corp health insurance?

Answer

Date:  30 Jun 2010

Hello Barb,

I am not a super expert on employee benefits and the IRS hasn't issued a ruling that I am aware of for Section 125 (cafeteria or flexible spending accounts) for S corporations.

I don't see any prohibition from your daughters or daughter-in-law participating in the Section 125 plan.

According to Internal Revenue Code Section 1372, for employee benefits, 2 percent S corporation shareholders, including persons considered as owning stock under Internal Revenue Code Section 318, are taxed as partners for their employee benefits.

Under Section 318, children are considered owning their parents' stock, so your daughters are subject to that limitation.

The IRS has issued Revenue Ruling 91-26, Announcement 92-16, and Notice 2008-1 with guidance about how health insurance benefits should be treated when an S corporation provides health insurance to shareholders owning 2% or more of the corporate stock (2 percent shareholders), including their children. The health insurance payments (apparently including those paid through the Section 125 plan) are treated as additional wages paid by the S corporation and 100% of the amount is deducted at line 29 of Form 1040 as self-employed medical insurance. The amount paid for the medical insurance (apparently including the amount paid through the Section 125 plan) should be reported on Form W-2 as S corp health insurance. The wages attributable to the medical insurance shouldn't be subject to employment taxes.

Since your daughter-in-law is not your child, she is treated like other employees and is not subject to the 2 percent S corp shareholder limitations.

Good luck!


Mike Gray

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