Subchapter S Owner Employee

[Below Ground]

I know that in the past a person who was a "2% S-Corp Owner" (direct or indirect with 318 attribution) was precluded from participating under a Section 125 Plan. I have a new client (401(k) Plan) that has a 125 Plan, and the spouse of the 100% Owner (S-Corp) is buying health insurance under the 125 Plan -- which actually covers the 100% Owner. While I know that there was an exemption for the spouse of a sole proprietor, I do not believe this is possible with an S-Corp. Is there some way that this is possible with an S-Corp? I note that I no longer work with 125 Plans so any recent changes would be unknown to me.

[J Simmons]

No recent change about the exclusion of an employee who is a 2%+ shareholder of the S corp employer, or his spouse, from the 125 plan. Those exclusions yet apply.

However, if it is just health insurance premiums that the shareholder/employee and spouse/employee are looking for, it could be provided by the S corp to the shareholder/employee, included in the shareholder/employee's W-2 taxable income, and then the shareholder/employee claims a deduction on his personal 1040. For self-employed, the income tax deduction is now 100% of the premiums so paid. As compared to other employees, such as those using the 125 plan, the only difference is that FICA taxes apply to the amount of the premiums for the shareholder/employee.

[Don Levit]

John:

When you say that FICA taxes apply to the shareholder-employee, is that because of Sec. 3121(a)(2), which states wages shall not include "the amount of any payment made to or on behalf of any employee or any of his dependents under a plan or system established by an employer which makes provisions for his employees generally and their dependents, or for a class or classes of his employees and their dependents, for medical or hospitalization expenses in connection with sickness or accident disability?"

Is this due to only the particular shareholder-employee being covered, rather than a bona fide class of employees?

Also, is the same FICA tax exclusion not available for the self-employed sole proprietor?

Don Levit

[GBurns]

It is simply that it is taxable income since it is neither excludible under 125, 106 or 105.

[LRDG]

I'm assuming it's because of the FICA exemption under Sec. 125, and that there is no FICA exemption when filing individual income tax returns.

[Below Ground]

Thanks John. As usual, your posts are very helpful. Do you, or anyone else, know where I can get supporting documentation (e.g. reg cite) for this issue? I got out of servicing 125 Plans when Schedule F was eliminated, so any help would be greatly appreciated. Again, thanks!

[GBurns]

The new 125 Proposed Treas Regs:

http://edocket.access.gpo.gov/2007/pdf/E7-14827.pdf

Page 4 has a blurb on eligibilty.

[Below Ground]

Thanks George! This was exactly what I needed. Thanks!