The health and accident insurance premiums paid on behalf of a 2% S corporation shareholder-employee are deductible by the S corporation as fringe benefits and are reportable as wages for income tax with-holding purposes on the shareholder-employee’s Form W-2, Wages and Tax Statement. They are not subject to Social Security or Medicare (FICA) or unemployment (FUTA) taxes. Therefore, this additional compensation is included in box 1 (Wages) of the Form W-2 issued to the shareholder, but is not included in boxes 3 (Social Security wages) or 5 (Medicare wages and tips) of the W-2. The health insurance amount is included as shareholder compensation on Form 1120S.
For this purpose, a 2% shareholder is any person who owns (or is considered as owning under the constructive ownership rules of Code Sec. 318), on any day during the S corporation’s tax year, more than 2% of the outstanding stock of the corporation OR stock possessing more than 2% of the total combined voting power of all stock of such corporation.
A 2% shareholder-employee is eligible for an above-the-line deduction for amounts paid during the year for medical care premiums if the medical care coverage is established by the S corporation. At one time, “established by the S corporation” meant that the medical care coverage had to be in the name of the S corporation. However, in Notice 2008-1, 2008-2 IRB 251, the IRS stated that if the medical coverage plan is in the name of the 2% shareholder and not in the S corporation’s name, a medical care plan can be considered to be established by the S corporation if it (1) either paid or reimbursed the 2% shareholder for the premiums, and (2) reported the premium payment or reimbursement as wages on the 2% shareholder’s Form W-2.
Health and accident insurance premiums paid on behalf of the shareholder may be further identified in box 14 (Other) of Form W-2. Neither Schedule K-1 (Form 1120S) nor Form 1099 should be used as an alternative to the Form W-2 to report this additional compensation.