Dependent Care and S-Corp Owner

[Guest Jo-Anne]

I am trying to figure out a way for an s-corp owner to receive tax-free dependent care assistance. I know that the owner cannot participate in a cafeteria plan, but is it possible to have a dependent care assistance program under section 129 where the company provides dependent care benefits to the owner, but all other employees (non-owners) must salary-reduce under section 125 to receive the benefits under the DCAP? Does this violate the discrimination rules in section 129? (Technically, the employer is providing the benefits in both situations since the 125 plan converts the employee contributions to employer contributions, right?) Any thoughts would be appreciated!

[Guest b2kates]

Jo-Anne

Regardless of how you try to structure it, the S Corp shareholder can not receive the benefit tax free. That is a consequence of being an S corp. For tax purposes the shareholder is treated as a partner and therefore the benefits flow to his personal return and not deductible at the corp level.

You may consider whether to void the S status, but is it material for 5000?

[Guest Jo-Anne]

Thanks for the reply Brett. It's definitely not worth voiding the S status for $5,000!

[Guest Jo-Anne]

Jo-Anne

Regardless of how you try to structure it, the S Corp shareholder can not receive the benefit tax free. That is a consequence of being an S corp. For tax purposes the shareholder is treated as a partner and therefore the benefits flow to his personal return and not deductible at the corp level.

You may consider whether to void the S status, but is it material for 5000?

Brett,

I looked into this a little bit more and I think the S Corp shareholder CAN get tax free benefits under section 129. Section 129(e)(3) says that the term "employee" includes an individual who is an employee within the meaning of section 401©(1) (relating to self-employed individuals). The problem is, though, that this language is not in section 125, so the S Corp shareholder cannot get the dependent care benefits through a cafeteria plan.

So, back to my original question - can there be one DCAP where the s-corp owner receives the benefits outside of section 125, but all other employees must salary reduce under section 125 to receive the benefits?

[GBurns]

Section 129 and section 125 are 2 separate items.

The issue rests on whether or not you have to participate in the section 125 cafeteria plan in order to participate in the DCAP, as pointed out by Jo-Anne.

Can the expense be paid directly by the S Corp and not be includable in the income of the shareholder? This probably is the real question, assuming no salary reduction under section 125.

[Guest mjb]

Under IRC 1372 employer fringe benefits provided to s corp owners are treated as benefits paid to a self employed person (SEP), e.g. includible in w-2 comp. The benefits may be deducted by the employee under the same circumstances as a SEP can deduct e.g, health ins is deducted on line 29 of the 1040. Since dependent care can be deducted by S corp owner to the same extent as SEP who is eligible for dep care under IRC 129, you need to review IRS form 2441 and the instructions to determine what can be deducted for dependent care. There are s corp owners who have established Dep care programs under IRC 129 where there are no other employees. If other employees participate in the plan it must meet the 55% test under IRC 129(d)(8).

[Guest b2kates]

how does a 1 person entity satisfy the discrimination rules of 129; or are you saying that in the 1 person scenario it does not apply.

[Guest mjb]

It doesnt apply since no benefits are paid to nhces (no different than 1 person 401k plan)