IRS Notice 2013-54 and S Corporation Shareholder-Employees

In a previous post we discussed IRS Notice 2013-54, in which the IRS reversed its previous position by indicating that, when an employer pays for an employee’s individual health insurance policy premiums, the benefit can no longer be provided on a pre-tax basis and must now be treated as taxable wages.  We encountered a situation recently which led us to conclude that, while it is not free from doubt, it appears that S corporation owner employees who directly or indirectly own at least 2% of the shares may now potentially be in a more favorable position than owner-employees of C corporations.

Let’s assume that a closely-held corporation offers a health insurance “plan” which consists of reimbursing individual health insurance premiums on behalf of an employee who is also a 50% owner.  In the case of a C corporation, the subsidy must now be treated as taxable wages for income tax and FICA purposes.  The owner-employee can take a medical expense itemized deduction for the premium, but this is worthless except in the unlikely event that he or she has sufficient other medical deductions to exceed the 10%-of-AGI threshold.

In the case of an S corporation with a similar arrangement, however, the result might be more favorable.  Until the IRS makes a pronouncement to the contrary, it appears that Notice 2013-54 does not affect the existing tax treatment and that the statutory language supports the following outcome:

Tax practitioners might find this to be an interesting turning of the tables, in that this is a counterexample to the general rule of thumb that C corporation status results in more favorable tax treatment of employee benefits for owners than does an S corporation.

 

E. Drew Cheney Posted By
E. Drew Cheney