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Partners' and S shareholders' fringe benefits.

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 less of an S corporation's stock is treated as an employee and not as a partner.

Rev. Rul. 91-26 stated that the IRS did not consider payments of medical insurance premiums by an S corporation for more-than-2% shareholder-employees as violating the single class of stock requirements under Sec. 1361(b)(1)(D). (See also Prop. Regs. Sec. 1.1361-1(l(2)(v), Example 4.)

Compensation attributable to medical insurance premiums paid by an S corporation for more-than-2% shareholder-employees is eligible for the same tax treatment as automobile fringe benefits. Based on discussions with the ruling's principal author, IRS employment tax personnel would allow these premiums to be treated under the fringe benefit rules.

Planning suggestion: An S corporation-employer may elect to treat taxable noncash fringe benefits provided in a calendar year as paid on December 31 (Ann. 85-113).

Ann. 92-16 states that Rev. Rul. 91-26 did not directly address the treatment of these wages for Social Security and Medicare tax purposes, and points out that

Section 3121(a)(2)(B) excludes from wages certain amounts paid by an employer to or on behalf of an employee (including amounts paid by an employer for insurance, annuities, or into a fund) for medical and hospitalization expenses in connection with sickness or accident disability. For this exclusion to apply, the payments must be made under a plan or system for employees and their dependents generally or for a class (or classes) of employees and their dependents. Thus, whether amounts of this type are actually subject to social security or Medicare tax depends on whether in the particular case the taxpayer satisfies the requirements for the exclusion.

If the requirements for the exclusion under section 3121(a)(2)(B) are satisfied, amounts paid by an S corporation for accident and health insurance covering a 2%-shareholder-employee are not wages for social security and Medicare tax purposes, even though the amounts must be included in wages for income tax withholding purposes on the 2%-shareholder-employee's Form W-2. On the other hand, if the requirements for an exclusion are not satisfied, amounts paid by an S corporation for accident and health insurance covering a 2%-shareholder-employee must be included in wages for social security and Medicare tax purposes, as well as for income tax withholding purposes, and reported in the appropriate boxes on the 2%-shareholder-employee's Form W-2.

A corresponding exclusion applies for FUTA purposes; see Sec. 3306(b)(2)(B).
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Article Details
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Author:Porter, Jack
Publication:The Tax Adviser
Date:May 1, 1992
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