Deductions for S Corporation Owners
Unlike the benefits costs paid by W-2 employees, which are pre-tax deductions in payroll, benefits paid by an S Corporation for its owners (any shareholders who own more than 2% of the company) are considered part of the owner's taxable wages, and aren't deducted in payroll.
For example:
- An S Corp owner is paid a gross weekly salary of $4000. They pay $25 per week for health insurance, and the company contributes $75 towards their premiums each week.
- Their gross pay is not reduced by the $25 deduction before taxes are calculated (as for a normal W-2 employee). The employer contribution is added as income to the gross for withholding calculations. (If the owner had dependent(s), the cost of their premiums would be added to their gross as well.)
- Thus, withholding amounts for Federal income taxes are calculated based on adjusted gross wages of $4100, but subtracted from the original gross of $4000. (FICA and any state income taxes are still calculated on the original gross amount). The $100 difference is the weekly benefits cost, which is paid to the insurance provider.
Learn more about how Zenefits can help S Corps to manage their owners' Medical Dental, Vision, Disability, and HSA benefits in payroll.
Why are Benefits Costs Considered Wages for S Corp Owners?
Owners of S Corps, like those in partnerships and sole-proprietorships, are considered self-employed. The IRS allows self-employed individuals to deduct the cost of their health insurance on their personal returns and reduce their gross taxable income.
Normally, the amount that a company pays towards pre-tax benefits for W-2 employees can be deducted as a business expense. However, S Corps transfer their profits and losses (e.g., business expenses) down to their owners, who declare these on personal tax returns. Thus, if an S Corp deducts an owner's premiums as a business expense, the expense (loss) would be passed down to the owner, who would then be unable to take the personal deduction as a self-employed individual.
To allow the owner to take the self-employment deduction, the S Corp includes the entire premium (employer contribution and employee deduction) as a payment to the owner on their W-2. As a result, in payroll, the owner pays income taxes on the entire premium. In most payroll systems, the entire payment is added to payroll as an S Corp Income item.
This page is intended to generally illustrate how benefits costs for S Corp owners are treated differently from other types of employees, and is not intended to provide tax advice or guidance. For more information, or to learn how these rules apply to a particular company and its owners, please consult a tax advisor.