As a shareholder-employee of an S-corporation, understanding how to handle medical insurance premiums can be crucial for tax planning and compliance. For those who own more than 2% of the corporation’s stock, treating medical insurance premiums is unique and requires careful attention.
This article will guide you through the process of adding these costs to your payroll, discuss their tax implications, and explain how this can support your stance on reasonable compensation with the IRS.
Adding Medical Costs to Payroll
For 2% shareholders, the cost of their medical insurance premiums paid by the S-corporation should be added to their W-2 wages to tax them correctly.
Here’s how to do it:
1. Determine Eligibility:
Verify that the medical insurance premiums are for a policy that the S-corporation has established.
This policy can be in the name of the S-corporation or the shareholder, as long as the S-corporation either pays the premiums itself or reimburses the shareholder and counts the reimbursement as taxable income.
2. Calculate the Premiums:
Total the amount of the medical insurance premiums paid during the tax year.
3. Include in Wages:
For federal income tax purposes, add the premium amount to the shareholder’s W-2 wages in Box 1. However, these amounts should not be included in Boxes 3 or 5, as they are not subject to Social Security or Medicare taxes (FICA).
4. Shareholder’s Tax Return:
The shareholder can then deduct the premiums from their tax return up to the limits set for self-employed individuals with health insurance.
Tax Implications: FICA and FUTA
The inclusion of medical insurance premiums in wages has specific tax implications:
The premiums are added to the shareholder’s taxable wages but are not subject to Federal Insurance Contributions Act (FICA) taxes.
This means that while the amount will be subject to federal income tax withholding, it will not be subject to Social Security and Medicare taxes.
Similarly, the premiums are not taxed under the Federal Unemployment Tax Act (FUTA). The overall employment tax burden is reduced, which benefits both the S-corporation and the shareholder.
Benefits Regarding Reasonable Compensation
Incorporating medical insurance premiums into the shareholder’s compensation can also play a strategic role in demonstrating reasonable compensation.
By including the cost of medical insurance in wages, the S-corporation can provide evidence of additional compensation to the shareholder. When the IRS looks into whether the shareholder’s salary is too low, this can be very helpful.
The IRS requires that shareholder-employees receive reasonable compensation for services rendered to the S-corporation.
The S-corporation further supports its claim that the shareholder receives fair compensation by including medical insurance premiums in the compensation package.
For 2% of S-corp shareholders, properly handling medical insurance premiums is essential for tax planning and compliance.
For the S-corporation and its shareholders, including these costs in the payroll can help with tax benefits while supporting reasonable compensation.
It’s essential to follow the correct procedures to ensure that these premiums are reported accurately and in compliance with IRS regulations.
As with all tax-related matters, consulting with a CPA or tax advisor familiar with S-corporation taxation is advisable to ensure that you’re meeting all requirements and maximizing your tax benefits.
In the last few years, the number of people who work as consultants on their own has grown quickly. These professionals have embraced the flexibility and independence of running a business single-handedly.
But with this freedom comes the responsibility of figuring out how to handle your taxes well. One effective tax planning strategy for consultant solopreneurs is converting their LLCs to S-Corp tax status with the IRS.
This article will discuss the benefits of this change and how it can make a consultant’s tax burdens much lighter. It will also talk about how important it is to follow the IRS’s rules for reasonable compensation.
Why Choose to be Taxed as an S-Corp?
Self-Employment Tax Savings
Saving on self-employment taxes is one of the main reasons to switch from an LLC to an S-Corp tax status.
As a solopreneur operating under an LLC, your net income is subject to self-employment taxes, including the employer and employee portions of Social Security and Medicare taxes. Unfortunately, this can mean that you have to pay a lot of taxes on your earnings.
By converting to an S-Corp tax status, you can classify a portion of your income as salary and the remaining portion as a distribution. Self-employment taxes will only be taken out of the portion that goes to the salary.
The part that goes to the distribution will not be taxed. This can help you save a lot on self-employment taxes, so you can keep more of the money you’ve worked hard for.
Reasonable Compensation and IRS Compliance
When choosing an S-Corp tax status, it’s important to follow the IRS’s rules about reasonable compensation.
The IRS requires that S-Corp shareholder-employees receive a reasonable salary for their services before taking any distributions. This means you can’t just lower your pay to avoid paying self-employment taxes.
When deciding reasonable pay, the IRS looks at many things, such as the employee’s role, responsibilities, hours worked, and pay rates for similar jobs in the same industry.
If you don’t pay yourself a reasonable salary, you could be audited, fined, or have your distributions reclassified as wages, which could cancel out the tax benefits of being an S-Corp.
Potential Income Tax Savings
In addition to saving money on self-employment taxes, S-Corp tax status may also save money on income taxes.
By splitting your income into a reasonable salary and distribution, you may be able to reduce your overall taxable income, potentially moving you into a lower tax bracket.
Furthermore, as an S-Corp, you can take advantage of certain tax deductions that may not be available to LLCs, such as the 20% qualified business income (QBI) deduction.
An S-Corp is like an LLC in that it has limited liability. This means your personal assets are generally safe from your business’s debts and liabilities.
Even though this benefit isn’t unique to S-Corps, it’s important to know that you won’t lose it if you change your LLC to an S-Corp for tax purposes.
How to Change the Tax Status of Your LLC to an S-Corp
Changing your LLC’s tax status to that of an S-Corp is a pretty simple process. You’ll have to send the IRS Form 2553, “Election by a Small Business Corporation.”
This form must be sent in within the first two months and 15 days of the tax year for which the choice will take effect.
It is essential to consult with a tax professional or attorney to ensure that you meet all the necessary requirements for the S-Corp tax status and properly navigate the conversion process, including determining and documenting reasonable compensation.
By switching your LLC to an S-Corp tax status, consultant solopreneurs can reduce their tax burden while still getting the benefits of limited liability.
By carefully adhering to IRS guidelines on reasonable compensation and working closely with tax professionals, you can optimize your tax savings and improve your overall financial position.
In the end, switching to an S-Corp tax status can help solopreneurs focus more on growing their consulting business and less on the complicated rules of taxes. This can help them be more successful and give them more financial freedom.