June 15, 2018
Fringe benefits are usually a good thing—but there’s a catch when you own more than 2 percent of an S corporation. The good news? Federal tax law allows the cost of these fringes as deductible expenses for your S corporation.
The bad news? You, the shareholder-employee who owns more than 2 percent, may suffer additional taxes on some of the benefits because the tax code requires your corporation to put selected benefits on your W-2. The outcome is sometimes favorable and sometimes not.
Here’s the ugly rule that causes this problem. Under the federal income and employment tax rules for the most popular fringe benefits, tax law treats the more than 2 percent shareholder-employee of an S corporation as a partner and denies the benefits. And—we know you are just waiting for this—there is more bad news: related-party stock attribution rules apply to the S corporation.
Under the related-party rules, tax law says that your spouse, parents, children, and grandchildren own the same stock you own—and if you employ them in your S corporation, their fringe benefits generally suffer the same ugly fate as your fringe benefits.