Health Insurance for S Corporation 2% Shareholders

The cost of health insurance premiums paid by an employer is usually excluded from taxable income on the employee’s W-2. A more than 2% shareholder of an S corporation is not eligible for this exclusion.

However, with health Insurance for S Corporation 2% shareholders, the 2% shareholder may be able to deduct the cost of the premiums on his Form 1040.

What is a 2% shareholder?

A “2% shareholder” is an S corporation shareholder who owns, directly or indirectly, more than 2% of the stock of the corporation on any day during the tax year.

Indirect ownership – family attribution rules

The following family members of a shareholder are treated as owning a shareholder’s stock for this purpose:

• Spouse
• Children
• Grandchildren
• Parents

Example 1

Karen sells her entire 10% interest in Flagco (a calendar year S corporation) on January 2, 2013. She continues to work at Flagco and receives health insurance through the company. Karen is a 2% shareholder of Flagco for 2013 because she owned more than 2% of Flagco’s stock on at least one day (January 1) in 2013.

Example 2

Justin is an employee of Flagco and receives health insurance through the company. He owns no Flagco stock. However, his father Jerry owns 75% of Flagco’s stock. Justin is a 2% shareholder of Flagco because he is deemed to own 75% of Flagco’s stock through the family attribution rules.

Tax treatment by the company

Health Insurance for S Corporation 2% Shareholders: Reporting to the shareholder

The cost of health insurance premiums paid by the S corporation for a 2% shareholder is included in the shareholder’s W-2 as Box 1 taxable income. The amount is subject to federal income tax withholding. It is not subject to FICA and FUTA taxes if the payments are made under a plan for employees generally or for a class (or classes) of employees. There is no definition of a class of employees, and there is no requirement that the class not be discriminatory. A plan normally exists if any one of the following applies:

• The plan is in writing or is otherwise made known to employees,
• There is reference to the plan in the employment contract,
• Employees contribute to the plan,
• There is a separate fund for payments apart from the employer's salary account, or
• The employer is required to make the payments.

If any one of these applies, the benefits are not subject to FICA and FUTA taxes and are not included in Box 3 or Box 5 of the W-2.

Deduction by the company

The S corporation can deduct the cost of health premiums paid for 2% shareholders on its Form 1120S income tax return. Since the premiums are treated as additional compensation to the shareholders, the deduction should be taken on page 1, Line 7 (Compensation of officers) or Line 8 (Salaries and wages). This reduces the net income (or increases the loss) which passes through to the shareholders on Schedule K-1. The deduction passes through proportionately to all owners. It cannot be specially allocated to the person who receives the income on Form W-2.

Tax treatment by the 2% shareholder

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