Case study: providing fringe benefits to S corporation employees.

• Author: Ellentuck, Albert B.

In a C CORPORATION, EMPLOYEE FRINGE BENefits generally are deductible at the corporate level, and the employee excludes the value from income. In an S corporation, employee fringe benefits paid on behalf of a 2% shareholder are subject to special rules.

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Sec. 1372(a) states that for fringe benefit purposes, an S corporation "shall be treated as a partnership" and a 2% shareholder "shall be treated as a partner of such partnership." A 2% shareholder is one that owns more than 2% of the corporation's outstanding stock on any day during the S corporation's tax year, considering direct and constructive owner 1372(a) and (b)).

S corporation employees and owners may be uncertain regarding which fringe benefits are subject to the 2% shareholder rules as well as the mechanics of implementing the restrictions. However, the cost of the fringe benefits subject to the 2% shareholder rules generally is included as compensation on the recipient shareholder's W-2 and is deducted by the S corporation as wages. Fringe benefits subject to the 2% shareholder rules include:

1. The cost of group term life insurance coverage up to $50,000 (Sec. 79);

2. Amounts received from accident and health plans (Sec. 105);

3. Contributions by an employer to accident and health plans (Sec. 106);

4. Meals and lodging furnished for the convenience of the employer (Sec. 119);

5. Employee achievement awards (Sec. 74(c); IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits);

6. Cafeteria plans (Sec. 125; Prop. Regs. Sec. 1.125-l(g)(2));

7. Qualified transportation fringe benefits (Sec. 132(f));

8. Adoption assistance programs (Sec. 137(c)(2));

9. Contributions by the corporation to health savings accounts (Sec. 223); and

10. Qualified moving expense reimbursements (Sec. 132(g)).

    Some fringe benefits are not subject to the 2% shareholder rules. The corporation can deduct the cost of these fringe benefits, up to the limits specified by the relevant Code section, regardless of the percentage of stock that the recipient shareholder owns. Further, they are excluded from the employee's income. These fringe benefits include:

1. Pension and profit-sharing plans (Sec. 401(c)(1));

2. Compensation for injury or sickness (Sec. 104(a)(3));

3. Educational assistance programs (Sec. 127);

4. Dependent care assistance (Sec. 129); and 5. No-additional-cost services, qualified employee discounts, working condition fringes, de minimis fringes, qualified retirement planning services...