Fringe benefit/distributions

I recently started working for an s corp. there are two shareholders which each own 50% and work in the company consistently. the company offers health insurance. however, one shareholder does not use this insurance and has personal health insurance and has been using the company to reimburse him/her through distributions. On the books, distributions have been equal. However, according to the IRS, this is a fringe benefit and has to be considered as wages, reported on the W2 in box 1 and considered as taxable income. ( I called and asked.)
Since this was a fringe benefit, can it also be a distribution? (I really don't think so.) Since this has to be reported as wages, does this make the distribution balance unequal? If so, how do I correct this problem before 2013 W2's are printed?

Answer :

1 : Health and accident insurance premiums paid on behalf of a 2% shareholder are reported as additional compensation to the shareholder. The value (normally cost) of the fringe benefit is added to the 2% shareholder’s wages. (However, the premiums can avoid employment taxes if made under a plan for employees and their dependents, or for a class of employees and their dependents.) .Since the 2% shareholder is not considered an employee for fringe benefit purposes, he or she cannot exclude the cost of the health insurance premiums from gross income as employer-provided coverage. However, the 2% shareholder may be able to claim the self-employed health insurance deduction. The deduction is not available for calendar months in which the 2% shareholder or spouse is eligible to participate in another employer-subsidized health insurance plan. Furthermore, the deduction is limited to the 2% shareholder’s earned income (i.e., the social security wages the shareholder receives from the corporation). Any portion that exceeds the earned income limitation is deductible as an itemized deduction, subject to the 10% (in 2013 unless the shareholder is over 65 yo.) of AGI floor for itemized medical deductions. When taxable fringe benefits are included in wage income, all shareholders will share in the corporation’s additional compensation deduction, according to each shareholder’s percentage ownership in the corporation (under the normal per-share, per-day allocation rules).

2 : Fortunately, payments of health insurance premiums for shareholders will not be considered distributions for purposes of the one-class-of-stock rule. Furthermore, fringe benefit programs are not considered “governing provisions;” therefore, providing fringe benefits will not create a second class of stock unless they are part of a plan to circumvent the one-class-of-stock rule.

3 : As the ownership percentages are equal, then the income and expenses reported to each owner will be equal. The IRS doesn't care if distributions are equal, but the actual distributions are tracked and reported through the Form K-1. If one owner gets more back in distributions than his basis (cost plus assumed liabilities), then some of distribution will be taxable. (Distributions reduce basis, but basis cannot go below zero.) .The S-Corp is required to file the forms correctly, which would include showing the amounts actually distributed to each shareholder on sch k1. Distributions of the income of a business which elected an S corp status are directly proportional...Read More...