S-Corp Fringe Benefit Background
There’s a reason why S corporations are the #1 business entity. They offer payroll tax savings along with pass-through taxation.
But there’s a big problem with S corporations. They do not have generous fringe benefit rules. Unless, you understand the workarounds.
In this post, we will discuss S Corp fringe benefit plans that are available to owners. We will explain the different plans and offer you some compliance tips. Let’s jump in!
Some Background
For C corporations, employee fringe benefits are typically deductible by the corporation, and employees do not include the value of these benefits in their income. However, for S corporations, special rules apply to employee fringe benefits provided to shareholders who own more than 2% of the company.
Sec. 1372(a) treats S corporations as partnerships for fringe benefits. A 2% shareholder is treated as a partner. This means any individual who owns more than 2% of the corporation’s stock, either directly or indirectly, at any time during the tax year (Secs. 1372(a) and (b)).
Fringe Benefit Rules
Navigating the rules for S corporation employee and owner benefits can be challenging. Employees and owners of an S corporation often face uncertainty about which fringe benefits fall under the 2% shareholder rules and how to comply. Typically, these benefits are included as compensation on the shareholder’s W-2 form and deducted by the corporation as wage expenses. Fringe benefits subject to these rules include:
- The cost of up to $50,000 of group term life insurance (Sec. 79);
- Amounts reimbursed under accident and health plans (Sec. 105);
- Company contributions to accident and health plans (Sec. 106);
- Meals and any lodging furnished for the employer’s convenience (Sec. 119);
- Employee achievement awards (Sec. 74(c); IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits);
- Employer sponsored cafeteria plans (Sec. 125; Prop. Regs. Sec. 1.125-1(g)(2));
- Qualified vehicle and transportation benefits (Sec. 132(f));
- Adoption assistance plans (Sec. 137(c)(2));
- Corporate contributions to health savings accounts (Sec. 223); and
- Eligible moving expense reimbursements (Sec. 132(g)).
Unlike the previously discussed benefits, some fringe benefits are not subject to the 2% shareholder rules. The next section details these exceptions. The company may deduct these benefits—subject to any applicable IRS Code limits—regardless of the shareholder’s ownership percentage. In addition, these benefits are not included in the employee’s income. Deductible fringe benefits may include:
- Defined benefit plans, pensions, and profit-sharing plans (Sec. 401(c)(1));
- Compensation for sickness or injury (Sec. 104(a)(3));
- Dependent care assistance (Sec. 129);
- Educational assistance programs (Sec. 127); and
- No-additional-cost services, working condition fringes, qualified employee discounts, qualified retirement planning services, de minimis fringes, and on-premises athletic facilities (Sec. 132).
Fringe Benefit Rules & Requirements
Work-related fringe benefits are excluded from employee income under Sec. 132. These are often referred to as statutory fringe benefits. Examples include qualified employee discounts, no-additional-cost services, working condition fringe benefits, de minimis fringe benefits, on-premises athletic facilities, qualified transportation fringe benefits, qualified moving expense reimbursements, and qualified retirement planning services. Except for qualified transportation and qualified moving expense reimbursements, 2% shareholders can get these on a tax-favored basis.
No-additional-cost services and qualified employee discounts must be offered equally to all employees. Qualified employee discounts apply only to services or products from the employee’s business unit. For example, a department store employee cannot get a tax-free discount on electrical components if they are made by a different division.
Understanding the Family Stock Attribution Rules
Under family stock attribution rules, a person is treated as owning stock held by their spouse, children, grandchildren, and parents (Sec. 318(a)(1), via Sec. 1372(b)). Stock considered owned by one family member cannot be counted again for another family member (Sec. 318(a)(5)).
For example, William owns 100% of the stock of ABC, Inc., an S corporation. William retired several years ago and appointed his son, Peter, as president and CEO of ABC. The corporation provides group medical insurance to all employees, including Peter. The premium cost for Peter for the current year is $3,000.
Peter is treated as owning all ABC, Inc. stock because his father owns 100%. The corporation must treat the insurance premiums for Peter as compensation. Peter’s taxable income increases by $3,000. William gets the corporate tax deduction because he owns all the stock. Peter might claim a tax deduction for medical insurance premiums under Sec. 162(l), but not for self-employment tax after 2010.
Taxable Fringe Benefit Treatment
Rev. Rul. 91-26 and IRS Announcement 92-16 clarify the treatment of certain fringe benefits. They address only health and accident insurance premiums. Rev. Rul. 91-26 states that health and accident premiums for 2% shareholders are reported as compensation, not fringe benefits, on Form 1120-S. Announcement 92-16 adds that these deemed wages are not subject to Social Security, Medicare, or FUTA taxes if paid under a Sec. 3121(a) plan.
A plan or system exists if it is written or made known to employees, mentioned in employment contracts, includes employee contributions, has a separate fund for payments, or requires employer payments.
Most professionals agree that Rev. Rul. 91-26 treats health and accident premiums for 2% shareholders as wages, rather than fringe benefits. Sec. 3401(a) wage rules require this treatment. The corporation adds this value to the shareholder’s wages and deducts it as a wage expense, not as a fringe benefit cost.
A 2% shareholder does not qualify as an employee for fringe benefit purposes and cannot exclude premiums from gross income as employer-provided coverage. However, the shareholder may take the self-employed health insurance deduction under Sec. 162(l).
Bottom Line
S-Corporation fringe benefits present a complex landscape of opportunities and restrictions that require careful navigation. While 2% shareholders face significant limitations on health-related benefits, understanding these rules allows for strategic planning and alternative approaches. The key is working within the tax code’s framework rather than against it, ensuring all benefit arrangements serve legitimate business purposes while maximizing available tax advantages. Smart S-Corp owners recognize that proper planning and professional guidance can help overcome many of the inherent limitations in S-Corporation benefit structures.
The most successful S-Corp benefit strategies involve a combination of direct corporate benefits for eligible employees and creative structuring for ownership participants. Alternative entity arrangements, when properly implemented, can provide access to valuable benefits like Section 105 plans that would otherwise be unavailable. However, these strategies require ongoing compliance monitoring, proper documentation, and genuine business operations to withstand potential IRS scrutiny. The investment in professional guidance and additional administrative complexity is often justified by the substantial tax savings and improved benefit coverage achieved.
