Partners' and S shareholders' fringe benefits.

• Author: Porter, Jack

Rev. Rul. 91-26 addressed the treatment of medical insurance premiums and other fringe benefits paid by a partnership or S corporation for a partner or more-than-2% shareholder.

Partnerships and partners

Premiums paid by a partnership for a partner are guaranteed payments if the premiums are -- paid for services rendered as a partner; and

--determined without regard to the partnership's income.

Therefore, the premiums are deductible by the partnership (subject to the uniform capitalization rules) and includible in the recipient-partner's gross income. The premiums must be reported on Schedule K-1 (Form 1065).

The partner may deduct 25% of these premiums in computing his adjust gross income (AGI), subject to specified conditions (see Sec. 162(l)). This special deduction is scheduled to expire June 30, 1992.

The remaining premiums may be claimed as medical expenses, which are deductible to the extent they exceed 7 1/2% of the partner's AGI.

Alternatively, a partnership may account for these premiums as a constructive distribution to the partner. In this event, the premiums would not be treated as guaranteed payments, but the partner would be eligible for the special 25% deduction and the medical expense deduction.

Observation: The rationale of these new rules would appear applicable to other fringe benefits, such as the group-term life insurance coverage up to $50,000, which are taxable to partners but not to employees.

S corporations and

more-than-2% shareholders

For example fringe benefit purposes, an S corporation is treated as a partnership and a more-than-2% shareholder is treated as a partner (Sec. 1372). Therefore, medical insurance premiums paid by an S corporation for a more-than-2% shareholder-employee, as a consideration for services rendered, are treated like guaranteed payments. (See the Tax Clinic item, "S Corporations and Fringe Benefits Are Addressed Again in Rev. Rul. 91-26," TTA, Aug. 1991, at 519.)

The corporation must include these premiums in the more-than-2% shareholder-employee's wages on Form W-2. The more-than-2% shareholder-employee is also eligible for the special 25% deduction and the medical expense deduction.

However, unlike a partnership, an S corporation may not account for medical insurance premiums paid for a shareholder-employee as a reduction in his distributions, since the shareholder's pro rata share of the S corporation's income is not subject to employment taxes.

Observation: An employee owning 2% or...