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S-corp 2% shareholder health insurance not reported on W-2


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I agree that if the health insurance benefit for a >2% S-corp shareholder is included in W-2 Box 1, it is included in plan compensation (we use W-2 definition) and 415 comp.  But I've got an accountant (several, actually) who doesn't get that information to be added in - he claims that his way, it ends up deductible to the employee, not the S-corp, so he doesn't bother adding it to the W-2.  Plus, it means he doesn't have to chase it down while preparing W-2s.  I'm not an accountant, so I don't know how OK that is, but what I do know is that there are some participants whose "compensation" is significantly affected by this, and are now receiving a few thousand less in profit sharing.

Is there a leg for us to stand on as TPA to add that amount in, even though it's not on the W-2?  Or do we just tell the plan sponsors to get more diligent CPAs?  Thanks.

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4 hours ago, AlbanyConsultant said:

I agree that if the health insurance benefit for a >2% S-corp shareholder is included in W-2 Box 1, it is included in plan compensation (we use W-2 definition) and 415 comp.  But I've got an accountant (several, actually) who doesn't get that information to be added in - he claims that his way, it ends up deductible to the employee, not the S-corp, so he doesn't bother adding it to the W-2.  Plus, it means he doesn't have to chase it down while preparing W-2s.  I'm not an accountant, so I don't know how OK that is, but what I do know is that there are some participants whose "compensation" is significantly affected by this, and are now receiving a few thousand less in profit sharing.

Is there a leg for us to stand on as TPA to add that amount in, even though it's not on the W-2?  Or do we just tell the plan sponsors to get more diligent CPAs?  Thanks.

"I'm not an accountant, so I don't know how OK that is..."

It's NOT OK at all!  He's ignoring the law and, if he's signing the tax return, he is in violation of his professional ethics and can be censured or even removed from practice.  You don't get to pick and choose the rules you will follow.

If this were my situation, I would have to contact the client and let him know the problem and let him decide what to tell the accountant.  In either case, I'm going to want something in writing from the client telling me to add the appropriate amount to the reported comp or not add it, and then it's his problem.  And I would certainly point out the danger of what you note in your last sentence (first paragraph): what I do know is that there are some participants whose "compensation" is significantly affected by this, and are now receiving a few thousand less in profit sharing.

Lawrence C. Starr, FLMI, CLU, CEBS, CPC, ChFC, EA, ATA, QPFC
President
Qualified Plan Consultants, Inc.
46 Daggett Drive
West Springfield, MA 01089
413-736-2066
larrystarr@qpc-inc.com

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I agree with Larry that this is not ok, but the degree of "wrongness",  ability of corrective measures and consequences depends on exactly what the CPA is doing. From your description that is not entirely clear.

The only proper procedure is for the :

  • S-Corp to pay or reimburse the health insurance premiums.
  • S-Corp to include the health insurance premiums on Form 1120S, Line 7 Officer compensation.
  • S-Corp to include the health insurance premiums in the 2% shareholder-employees W-2 Box 1 wages, but not Box 3 SS wages and Box 5 Medicare wages.
  • 2% shareholder-employee to claim the self-employed health insurance deduction. Provided they are not eligible to be covered under their, their spouse or their dependent's employer subsidized health insurance plan.

It kind of sounds like the CPA might not be involving the S-Corp at all with the health insurance premium, but they are not so nearly smart as they think they are. In that case there is no problem with the S-Corps 1120S, Form W-2 reporting, or the 2% shareholder-employees failure to report compensation. However, there are two big problems.

There is no 2% shareholder-employee compensation to be added to their W-2 Box 1 compensation to base employer retirement plan contributions on. Even worse, the self-employed health insurance deduction is only available for 2% shareholder-employees if the the premiums were paid or reimbursed by the S-Corp and included in their W-2 Box 1 wages. See IRS Notice 2008-1*, claiming the deduction in these circumstances would be tax evasion.

*This notice provides rules under which a 2-percent shareholder-employee in an S corporation is entitled to the deduction under §162(l) of the Internal Revenue Code for accident and health insurance premiums that are paid or reimbursed by the S corporation and included in the 2-percent shareholder-employee’s gross income.

If the health insurance premiums were paid or reimbursed by the S-Corp and CPA is claiming the 2% shareholder-employees health insurance premiums as S-Corp deductions on Form 1120S would be fraudulent. Pass-thru business owners can never be the beneficiary of pre-tax health benefits. Regardless the paid or reimbursed health insurance premiums must be still reported as taxable wages. I'm not sure if failure to include the health insurance premiums as Officer compensation would be fraudulent, but it would inflate the S-Corp's ordinary income used to calculate the QBI deduction. Failure to to include the compensation and report it on Form W-2 could also be a reporting error.

I would think most plan documents would require plan compensation to be that compensation claimed by the business and reported on Form W-2 Box 1. Here again, failure to include the health insurance premiums in Officer compensation and included in W-2 Box 1 wages, precludes taking the Self-employed health insurance deduction on Form 1040.

I don't know why TPAs so often have to do CPA's jobs for them even when it does not involve employer retirement plan issues.

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I just spoke to another client about this who uses Paychex.  She said that she called in the shareholder premium information at the end of the year, and it shows up on the W-2 as a note... but it's not reflected in Box 1.  If one of the largest payroll companies can't do this properly, then what hope is there?  I know, the answer is to find a better payroll company, but they do payroll for thousands and thousands of S-corps; they can't be willfully getting it wrong, can they?

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2 minutes ago, AlbanyConsultant said:

I just spoke to another client about this who uses Paychex.  She said that she called in the shareholder premium information at the end of the year, and it shows up on the W-2 as a note... but it's not reflected in Box 1.  If one of the largest payroll companies can't do this properly, then what hope is there?  I know, the answer is to find a better payroll company, but they do payroll for thousands and thousands of S-corps; they can't be willfully getting it wrong, can they?

There is a difference between willfully and stupidly.  They aren't smart enough to do it willfully!

Lawrence C. Starr, FLMI, CLU, CEBS, CPC, ChFC, EA, ATA, QPFC
President
Qualified Plan Consultants, Inc.
46 Daggett Drive
West Springfield, MA 01089
413-736-2066
larrystarr@qpc-inc.com

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Spoke to another friendly CPA this morning about this and got some interesting feedback:

> Other TPAs that he works with [but clearly not us] are just taking whatever is on the W-2 Box 1 and not asking any further questions.

> Some CPAs don’t take the deduction for the premiums on the S Corp so then the K-1 income is higher and then they take the deduction on the personal 1040.  So as we have heard, mathematically they work out on their side.  The IRS has made it clear that they are supposed to put it in box 1 of the W-2, but upon audit, no action has been taken against them (this being the key for why they are not changing anything).  This ruling of having to put it in the W-2 was the IRS’s way of kicking the can down the road to be a problem they would deal with later and the IRS has never gotten back to it.


 

So the accountants and payroll companies have no incentive to change the way they are doing things because they are not being penalized for doing it the wrong way.  They are leaving pension allocations on the table for their clients, but 99% of their clients don't realize that.

 

Does using a different definition of compensation fix this?  As originally noted, we use a W-2-based compensation definition.  Does changing to 3401(a) or 415(c)(3) as the definition of "plan compensation" (we're using a Datair document) get around this problem (without causing a host of new ones)?

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