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Fringe benefits are normally excluded from taxation for employees. However, shareholders of an S corporation who hold more than 2 percent of the S corporation stock receive special treatment. Like to learn more?
Fringe benefits are normally excluded from taxation for employees. However, shareholders of an S corporation who hold more than 2 percent of the S corporation stock receive special treatment. S corporations pass their income through to shareholdings instead of paying taxes at the company level, so the taxation rules are different from the rules for other types
of organizations. Two-percent shareholders are also designated as owners and are prohibited from participating in Section 125 plans.
IRC Section 1372(a) states that for fringe benefit purposes, an S corporation “shall be treated as a partnership” and a 2% shareholder “shall be treated as a partner of such partnership.” A 2% shareholder is one that owns more than 2% of the corporation’s outstanding stock on any day during the S corporation’s tax year, considering direct and constructive
ownership (IRC Sections 1372(a) and (b)).
This means that S corporation stock owned by an individual is also considered to be owned by the shareholder’s spouse, child, parent, and grandparent. Thus is a shareholder’s family member also works for the company, that individual may be considered a 2% S corporation shareholder and subject to the same fringe benefits rules as the 2% shareholder.
S corporation employees and owners may be uncertain on which fringe benefits are subject to the 2% shareholder rule as well as the mechanics of implementing the restrictions. However, the cost of the fringe benefits subject to the 2% shareholder rules generally is included as compensation on the recipient shareholder’s W-2 and is deducted by the S corporation as wages.
Fringe benefits subject to the 2% shareholder rules include:
1. The cost of group term life insurance coverage up to $50,000 (IRC Section 90);
2. Amounts received from accident and health plans (IRC Section 105);
3. Contributions by an employer to accident and health plans (IRC Section 106);
4. Meals and lodging furnished for the convenience of the employer (IRC Section 119);
5. Employee achievement awards (IRC Section 74(c));
6. Cafeteria plans (IRC Section 125);
7. Qualified transportation fringe benefits (IRC Section 137(f);
8. Adoption assistance programs (IRC Section 137 (c)(2));
9. Contributions by the corporation to health savings accounts (IRC Section 223); and
10. Qualified moving expense reimbursements (IRC Section 132(g)).
Some fringe benefits are not subject to the 2% shareholder rules. The corporation can deduct the cost of these fringe benefits, up to the limits specified by the relevant IRC Section, regardless of the percentage of stock that the recipient shareholder owns. Further, they are excluded from the employee’s income.
These fringe benefits include:
1. Pension and profit-sharing plans (IRC Section 401(c)(1));
2. Compensation for injury of sickness (IRC Section 104(a)(3));
3. Educational assistance programs (IRC Section 127)
4. Dependent care assistance (IRC Section 129); and
5. No-additional-cost services, qualified employee discounts, working condition fringes, de minimis fringes, qualified retirement planning services, and on-premises athletic facilities (IRC Section 132).
Special note regarding Dependent Care Assistance: Not more than 25 percent of the amounts paid or incurred by the employer for dependent care assistance during the year may be provided for the class of individuals who are shareholders or owners (or their spouses or dependents), each of whom (on any day of the year) owns more than 5 percent of the stock or of the capital or profits interest of the company.