What is definition of 'employee"...as the word "employee" is used in IRC 106(a) ?

[Guest Moe Howard2]

The lone shareholder of a corporation works an average of 25 hours a week at his corporation, tending to the business affairs of the corporation. He has never taken a salary from the corporation (he receives no W-2). The corp has two regular full-time employees (one bookkeeper and one delivery man). They are paid a salary and each receives a W-2.

Can the corp establish a fully-insured medical plan that reimburses medical insurance premiums paid just by the shareholder (for the shareholder)?

IRC 106(a) says that "gross income of employee does not include employer provided coverage under a health plan" ...... BUT IRC 106(a) does not define the word "employee"?

Does employee mean only a worker that gets paid ?

Where can I find the IRC definition of "employee" as it relates to 106(a) ?

[Ron Snyder]

Regs. 1.410(b)-9

EMPLOYEE. EMPLOYEE means an individual who performs services for the employer who is either a common law employee of the employer, a self-employed individual who is treated as an employee pursuant to section 401©(1), or a leased employee (not excluded under section 414(n)(5)) who is treated as an employee of the employer-recipient under section 414(n)(2) or 414(o)(2). Individuals that an employer treats as employees under section 414(n) pursuant to the requirements of section 414(o) are considered to be leased employees for purposes of this rule. In addition, an individual must be treated as an employee with respect to allocations under a defined contribution plan taken into account under section 1.401(a)(4)-2©(ii) and with respect to increases in accrued benefits (within the meaning of 411(a)(7)) under a defined benefit plan that are based on ongoing service or compensation (including imputed service or compensation) credits.

[Don Levit]

According to the IRS publication 15B, Employer's Tax Guide to Fringe Benefits, under Accident and Health Benefits it defines an employee as:

1. A current common-law employee

2. A full-time life insurance agent who is a current statutory employee.

3. A retired employee

4. A former employee that you maintain coverage for based on the employment relationship.

5. A widow or widower of an individual who died while an employee.

6. A widow or widower of a retired employee.

7. For the exclusion of contributions to an accident or health plan, a leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.

Don Levit

[GBurns]

Section 106 has nothing to do with the issue outlined. 106 only provides exclusion from the employee's gross income of the amount that the employer pays for the coverage provided to the employee. However, Treas Regs 1.106-1 directs you to "paragraph (d) of 1.104-1 and 1.105-1 through 1.105-5, inclusive, for regulations relating to exclusion from an employee's gross income ..." TWithin 1.105 including 1.105-11 you will find the definition and references to the definition of "employee".

Reimbursing paid by the shareholder would be an issue for section 105.

I have questions about your wording "paid just by the shareholder (for the shareholder)". Were the premiums paid by the shareholder or by the Corporation?

You also did not state whether this was an S Corp or a C Corp. If an S corp, 2% or greater shareholders are generally not eligible to participate in most benefit plans.

There is also the problem of his rendering services but not being an employee.

Reimbursement can be done only for employees, former employees, their spouses and dependents. It cannot be done for Directors and non-employees. Employees get a W2.

This person gets neither salary nor W2 and therefore is not an employee and so not eligible for participation in any plan.

You might want to look at the section on Accident and Health Plans in the IRS FAQ:

http://www.irs.gov/faqs/page/0,,id=83301,00.html#27

Pay special attention to 1.105-11

[Guest Moe Howard2]

Hey guys, thanks! But none of you answered my question ... Does "employee" (re: IRC 106) mean only a worker that gets paid?

vebaguru: According to what you say ..."an employee is an individual that performs services for the employer". The definition you quote says nothing about the individual having to be paid. So, it appesrs to me that payment for services is not a requirement of being deemed an employee.

Don Levit: (Are you any relation to Mel Levit, a former tv anchor man in New Orleans?). Anyway, the things you list from IRS pub 15B make no mention of payment for services being required.

GBurns:

I did not find a definition of "employee" in Reg 1.105.

I disagree with you belief that reimbursements of fully-insured premiums paid by shareholder is an issue for 105. Because 105 deals only with self-insured plans. My question is regards to fully insured coverage.

The premiums were paid by shareholder and reimbursed to him by the corp. (See Rev Ruling 61-146).

It's a C-Corp. (By the way, 2% or greater shareholder employees of an S-corp can participate in any and all benefit plans according to ERISA ...however, the IRS requires them to be taxed on the employer paid premiums).

You say that because the person gets neither salary nor W-2 then he is not an employee and not eligible to participate....but you did not cite you sourse for that belief.

------------------------------------------

The question still remains: Although he performs services for free, are the employer paid premiums non-taxable to him ?

[Guest b2kates]

let me weigh in, not checking the IRC but shooting from the hip.

It is my recollection that employee is not a defiined term within the Code, but within Section 3121 and 3405 there are some specifics of who is an employee; i.e. a corporate officer.

There may be a problem should the medical insurance carrier audit the coverage. In that there is usually a minimum number of hours that must be worked.

Also, who works " for no pay" might appear to violate the minimum wage laws.

[GBurns]

moehoward2,

Responding to most of your last post seems pointless. The reason being that you seem to lack the basics of the issues.

You do not understand what 106 covers.

You do not understand what 105 covers.

As a result any explanation would be pointless until you read those sections and especially their related Treasury Regulations. At the least read what the IRS gives at the link provided.

[GBurns]

moehoward2,

Definition of employee:

IRC 3121(d). Note the test in paragraph (b) regarding officers. Of course you might need to understand the difference between an Officer, a shareholder and a Director.

Treas Regs 31.3121(d)-1

Explanation of IRS position:

http://www.findarticles.com/p/articles/mi_...193/ai_87570366

The relevance of 3121 and 3405 etc is that amounts under 104, 105 and 106 are exclusions from Gross income. The taxation of Gross Income is outlined in 3121, 3405 et al.

C Corps are even more clear cut because of the stricter enforcement and structural adherence to the separation of duties whether imposed by the By-Laws of the Corporation and/or by the state Corporation Law.

http://www.bdo.com/about/publications/industry/re_summer02/

[Guest Moe Howard2]

Ah! yes ....I do believe that b2kates has found something in IRC 3121.

Since the individual is the lone shareholder, then it stands to reason that he might be a corp officer. (Guess what? ... he is the president of the corp).

My reading of IRC 3121(d)(1) tells me that since the individual is a corp officer who provides services to the corp (even though he is paid no compensation for those services) ... then he is an employee.

b2kates: Both GBurns and I thank you for informing us about IRC 3121.

[GBurns]

A shareholder is an investor in the corporation, company or venture etc.

A shareholder, whether sole, major or otherwise does not have to be either an Officer nor a Director. A large number of sole shareholders are not Officers of the companies that they funded, started or invest in. There is no logical reason to state "then it stands to reason that he might be a corp officer" because there is no reason why any shareholder has to be an Officer, other than personal preference.

I am the sole shareholder in a lawnmower equipment repair facility that is a C corp. I employ a CEO, I am neither an Officer nor an Employee, I am only a Director. This is a very common scenario among people who invest in small enterprises. Also very popular is to be just the major shareholder or "silent partner" in a venture with someone who has a certain expertise but who lacks the capital and/or business handling capability. The major shareholder quite often will be a Director but not a Corporate Officer.

But understanding what the relevant definition of an "employee" is, still does not address most of the original post, anyhow.

[mbozek]

In the unlikely chance that the employer is audited, to demonstrate employee status under IRC 3121(d) there should be a written employment contract between the corporation and the shareholder defining the services he will perform for the corporation and his remuneration which can be the payment of the health care premiums by the corp.

[GBurns]

Remuneration that consists of, or is equal (or nearly equal) to, the costs of benefits provided, whether health insurance premiums, IRA or pensioncontribution etc, has been an issue in a number of cases in which the IRS prevailed, and which were related to the questions of "bona fide" employee and reasonable compensation.

In the IRS Q&A at the links provided, the IRS cites some of these cases. Header, Wollenberg come to mind.

[mbozek]

Since the determination of status as an employee is an issue of fact, the purpose of having a written contract is to establish an position for audit that the shareholder is performing services as an employee if the IRS reviews the taxpayers return. In Header the spouse of the owner had no written contract defining her duties which in any event the ct determined were not employee functions. The purpose of the written contract to is to establish the duties to be performed by the shareholder for the corporation as an employee and the remuneration paid by the employer. It makes no difference if the employee's remuneration is paid in property (e.g., health ins), barter or cash compensation. A individual can be an employee if he works for $100 a year or $100,000 as long as he perform employee duties. If you think the shareholder needs a W-2 to be classified as an employee then he could receive $100 a year from the corp plus the health ins for the duties he performs.

If you had read Wollenberg you would have noticed that the ct held that the tax payer could not retroactively establish a health reimbursement plan for his spouse to cover expenses paid prior to the date the plan was adopted. It had nothing to do with the duties performed by the spouse.

[GBurns]

I only said that "Header, Wollenberg come to mind". That is why I did not quote from them nor cite them formally, I suggested that the cites given by the IRS be looked at instead.

Wollenberg:

Leola Wollenberg IS the spouse of Walter Wollenberg and there was an Employment Agreement and retroactivity of adoption although primary was not the only issue as a reading would show.

However, the issue was not whether she was a spouse or not but whether she was an employee for which they could adopt the Plan. While the issue was primarily the retroactivity of the plan adoption, other issues such as being a bona fide employee and the payment of premiums were issued raised and subsequently adjudicated.

Page 3, II ANALYSIS, A. Medical Expense Reimbursement, [*10] n3, "I have assumed for the sake of argument that Leola Wollenberg was Walter Wollenberg's employee during the relevant time frame. If Leola was not ..."

Page 2 states "Leola Wollenberg signed an "Employment Agreement" with Walter as employer and Leola as employee".

Page 4 "Premium Payments" also see "It is Ordered".

http://www.irs.gov/pub/irs-utl/wollenburg_v_comm.pdf

The issue of reasonable compensation is an issue frequently raised by the IRS and it is very difficult not to notice the frequency if one is involved in taxation and representation before the IRS or just research into taxation. Based on the frequency with which it is raised an an issue in cases in which the IRS prevail, it is more than foolhardy to casually think that any shareholder/employee, shareholder/Officer can be paid any minimal amount. In fact not even the most menial employee can be paid just any amount. Paying an employee $100 per year would not fly, neither with the IRS, the DoL or the State, and if any 1 shoots it down the rest follow suit.

The cites at the IRS link include this Coordinated Issue Paper:

http://www.irs.gov/pub/irs-utl/all-cafhealth.pdf

On page 2 under Law And Analysis, Issue 1: the last paragraph on page 2 has wording that is very frequently used in "reasonable compensation" cases and these accident and health related cases, namely, "Accordingly ...are deductible, if ...bona fide employee ...for which the accident and health coverage is reasonable compensation. However, if the "employee-spouse" does not meet this standard ...".

Rueschenberg:

http://www.irs.gov/pub/irs-utl/rueschenberg_v_comm.pdf

Here there was an employment contract but still the issue of reasonable compenastion was a primary issue. The employee benefits programs amount related to the amount the employer paid for himself and family. The disallowance was partially for failure to establish that the amount deducted each year was reasonable in amount in terms of "employee-spouse" overall compensation. The issue of "eligible employee" was also raised in relationship to hours worked related to compensation.

Haeder:

http://www.irs.gov/pub/irs-utl/all-cafhealth.pdf

While Haeder had no employment contract, the issue of reasonable compensation (or lack) was a major issue. On page 6 ".he based her salary on the maximum amount that a qualifying individual could deduct .... an IRA".

While most of the above cases are related to self employed situations, there are even more cases related to the issue of "reasonable compennsation" involving C Corporations. Asking a Tax Practitioner, visiting the Tax Court archives or doing a Google search on "IRS reasonable compensation" should get anyone numerous cases etc. sufficient to show that this is a major issue.

[mbozek]

The above cases relate to whether spouses were employees of a business, not whether the owner was an employee (and under IRS rules cannot be cited as precedent in other cases). There are many citeable tax cases holding that the sole owner of a corp who performs services is an employee of the business. e.g., Joeseph Grey 119 TC 121, Mike Graham Trucking Inc., 2003 WL 548574. Since determination of status as an employee is an issue of fact, the owner needs a written contract describing his duties and remuneration as an employee in the event his co. is audited for open tax years.