Which Tax-Free Fringe Benefits Can an S Corporation Provide to Shareholder-Employees?
Okay, so the good news is this: S corporations can save small business owners lots of income or payroll taxes. And that's great. But there's a bit of bad news about the S corporation option. An S corporation cannot provide as many tax-free fringe benefits to shareholders-employees as a traditional "C" corporation can. Nevertheless, an S corporation may still provide a number of tax-free benefits to S corporation shareholder-employees, including the following:
Qualified Retirement Plans
An S corporation may provide pension plans to employees, including shareholder-employees. Examples of popular S corp pension plan options include SEP plans (which let the S corporation make large contributions to employee IRAs), Simple-IRAs (which work like a "lite" 401(k) and allow for modest annual employee contribution limits and low-percentage employer matching contributions), and more big-business-y choices like the traditional 401(k) plan (which gives the S corp and its shareholder-employees rather large employee and employer contribution limits). One important note, however: S corporation shareholder employees receive retirement plan benefits based on their earned, W-2 income and not on their shares of the corporation profit.
Working Condition Fringe Benefits
A working condition fringe benefit is an expenditure that would be deductible as an employee business expense if directly paid by the employee. For example, if an employee would benefit from additional technical schooling, the employee can often go and get the schooling--and any costs are considered a tax-deductible employee business expense. The only problem with employee business expenses is that they're hard to claim as tax deductions because the itemized deduction rules tend to reduce their deductibility. However, if the employer rather than the employee pays for the schooling, the schooling expenses are working condition fringe benefits. The S corporation gets to deduct the cost. And--here's the good part in a sense--the employee is not taxed on the value on this educational benefit.
Note: An S corporation shareholder-employee could probably, for example, use the working condition fringe benefit loophole to pay for something like an MBA program. But be sure to consult your tax advisor if you want to do this, so you get the tax accounting just right.
If an S Corporation provides a vehicle to a shareholder-employee and the shareholder-employee uses that vehicle for business purposes, that use of the vehicle may be a tax-free fringe benefit to the shareholder-employee. Note, however, that only the business use component of the vehicle cost will be tax free. The personal use component of the vehicle cost should be counted as compensation paid to the employee and added to his or her W-2 wages. (By the way, even if you do add the value of the personal use of a vehicle to the shareholder-employee's W-2, this gambit may still save on income taxes.)
De Minimis Fringe Benefits
A de minimis fringe benefit refers to small, hard-to-track benefits that an employee receives. Free coffee at work. That thanksgiving turkey. The annual company holiday party or picnic, and so on. The rationale for treating de minimis fringe benefits as deductions to the employer but as "tax-free" income to the employee is that the dollar amounts involved are too small to justify the extra bookkeeping burden.
Other Fringe Benefits
An S corporation may also offer shareholder-employees several other miscellaneous tax-free fringe benefits. For most small S corporations, very honestly, these miscellaneous tax-free fringe benefits don't amount to big money savings. But if you're looking to minimize your taxes, you may want to confer with your tax adviser about the following potential fringe benefits: deferred compensation, dependent care assistance, job placement assistance, no-additional-cost services, on-premises athletic facilities, qualified employee discounts, and retirement planning services. Note, however, a general rule about all of this stuff: The employer can't discriminate in favor of highly-compensated employees or shareholder-employees.
Additional Information You May Find Useful
If you want additional information about how to maximize the tax savings related to running a business or investment venture, you may also be interested in one of our downloadable e-books (see descriptions below). Each book covers a category of tax planning topics that easily save a business owner significant amounts of income or self-employment taxes (potentially thousands of dollars a year) and is instantly downloadable.
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