Businesses operating as S corporations have many of the same benefits of passthrough taxation as partnerships or LLCs. However, S corporations have always had unique issues with respect to health insurance premiums paid to their more than 2% shareholders. With the Affordable Care Act (ACA), even more issues have arisen with respect to health insurance, and S corporations are especially affected by these new rules.
CPAs have always had to deal with complex issues relating to S corporations, such as reasonable compensation, shareholder requirements, basis issues, and elections; ACA brings another layer of complexity for CPAs to serve the needs of S corporation clients.
Here are some common questions CPAs are asking about their S corporation clients affected by ACA:
First, for an S corporation that has a group health insurance plan, there should be no change in the treatment of these benefits under ACA. The group premiums paid for employees, other than the more than 2% shareholder, are deductible by the corporation as fringe benefits, and are not taxable wages to the employee. For an employee who is a more than 2% shareholder (and for any person who owns, or is considered to own within the meaning of Sec. 318, more than 2% of the outstanding stock; see Sec. 1372(b) and 318), report group premiums paid in box 1 of his or her Form W-2. Do not include them in box 3 or 5 for Social Security or Medicare tax purposes. Since a more than 2% shareholder is treated as a partner for the purpose of the self-employed health insurance deduction, the shareholder/employee can deduct the premiums on page one of his or her Form 1040 so that the net effect to his or her income is that the wages are included in income, but the health insurance premiums paid by the company are, in effect, excluded by the netting of the deduction against the same amount included in wages. This is the most straightforward case, and will apply to larger S corporations that have group plans in place and pay reasonable wages to their more than 2% shareholders who work in the business.
The real impact of ACA on S corporations comes into play when there is no group plan for the business, but the business wants to pay premiums directly for shareholders or employees for individual policies, or wants to reimburse the shareholders or employees for premiums that they have paid personally.
Generally, under ACA, arrangements that provide reimbursements for medical costs to employees are not allowed. Under ACA, a medical reimbursement plan, or a similar plan that covers employee premiums, is not permitted unless it provides only ancillary benefits (dental, vision, etc.), covers only one participant, or is integrated with a fully qualifying group plan. In essence, an arrangement where an S corporation reimburses individual premiums, even if the premiums are reported as taxable income, is a violation of the ACA market reform rules. While these rules were to be effective beginning in 2014, the IRS issued Notice 2015-17 in February of 2015 which provided some relief. That notice provided that no penalties would be assessed for non-compliant reimbursement arrangements for small employers with less than 50 employees who directly pay or reimburse individual health insurance premiums from 1/1/14 through 6/30/15. It also provided that S corporations that directly pay or reimburse individual premiums for more than 2% shareholders are exempt from any penalties under ACA for such arrangements.
Special note: As indicated in Notice 2015-17, the Departments are contemplating publication of additional guidance on the application of the market reforms to a 2% shareholder-employee healthcare arrangement. Until such guidance is issued, the excise tax will not be asserted for any failure to satisfy the market reforms by a 2% shareholder-employee healthcare arrangement. Further, unless and until further guidance is issued, an S corporation with a 2% shareholder-employee healthcare arrangement will not be required to file Form 8928, Return of Certain Excise Taxes Under Chapter 43 of the Internal Revenue Code, solely as a result of having a 2% shareholder-employee healthcare arrangement.
Hopefully, S corporation clients have already faced the issue regarding employee reimbursements since the June 30 expiration date for relief has passed. Any employer who continued to reimburse or directly pay premiums for an employee after June 30, 2015, whether the employer is an S corporation or not, faces penalties.
Those employers should cease those arrangements. Instead of directly paying or reimbursing employees for those premiums, if the employer wants to assist the employee in paying for his or her individual insurance, the employer should increase the employee’s pay with additional taxable compensation, and then the employee can pay whatever individual premiums are needed with after-tax dollars. If a CPA learns that a client did not stop the arrangement after June 30, at a minimum, any premiums paid on behalf of an employee should be included in the employee’s taxable wages for 2015. This may involve amending quarterly payroll tax returns, grossing up pay for taxes that should have been withheld, and making sure the Forms W-2 are prepared correctly.
The Department of Labor (DOL) has stated that an arrangement violates ACA market reform without regard to whether the employer treats the money as pre-tax or post-tax to the employee; therefore, a simple recharacterization of a reimbursement accomplishes nothing. Nevertheless, an employer can pay an employee additional compensation without any requirement that the amount be used for insurance premiums. For any amounts already reimbursed or paid directly in 2015, changing the arrangement as soon as possible and correcting the error by including the amounts in compensation should be sufficient for relief from penalties if the failure was due to reasonable cause and not willful neglect.
Since the exemption from penalties for more than 2% shareholders applies (unless and until further guidance is released), CPAs can continue to report the premiums paid directly or reimbursed to the shareholder/employee. CPAs need to advise S corporation shareholders that the treatment for these arrangements is not clear for the future because no guidance specifically for more than 2% shareholders has been given by the IRS.
The penalty for noncompliance is an excise tax of $100 per day per individual to whom the failure applies, as provided under Sec. 4980D of the Internal Revenue Code. If the failure was due to reasonable cause and not due to willful neglect, and if it is corrected within 30 days of the first date that anyone liable for the tax knew that the failure existed, the additional tax is not due. A minimum excise tax of $2,500 per individual is due if one or more failures occurred and were not corrected when a taxpayer is under audit by the IRS. There are also additional excise taxes if the failure is due to willful neglect or otherwise not due to reasonable cause.
Any penalties for noncompliance with the ACA market reform requirements are to be self-reported on Form 8928, Return of Certain Excise Taxes Under Chapter 43 of the Internal Revenue Code. This form must be filed on or before the due date for filing the employer's federal income tax return, and an extension of time for filing Form 8928 may be requested on Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns. Form 8928 is filed separately with the IRS in Cincinnati, OH.
Employers should take these penalties seriously and CPAs should consult with their clients about whether Form 8928 should be filed. If the CPA is not aware of any arrangement that a client may have that violates ACA, he or she should still discuss the issue with clients (especially small business clients) to provide the appropriate warning of the excise taxes that could be due. The proactive response by the CPA is important not only for legal purposes, but to ensure that no penalties could be assessed to the preparer.