We are receiving a number of questions from dealers who have heard that the Tax Cuts and Jobs Act of 2017 (The Act) contains changes to tax law which will result in “Buy Here Pay Here” or BHPH dealers no longer needing to use a related finance company (RFC). The Act, the most comprehensive tax legislation since the Reagan era, is very complicated and we expect a significant number of regulations implementing the new law to be issued in the coming months and years.

One of the items contained in The Act is an expansion of the use of the cash method of accounting for businesses. Taxpayers using the cash method of accounting recognize income when cash is received and deduct expenses when paid. In general, the accrual method recognizes revenue when it is earned and expenses as incurred regardless of when payment for those items are received or paid.

Under prior law, there have been limitations on using the cash method of accounting. One of these limitations impacts taxpayers who maintain inventories. Generally, taxpayers with inventories are required to use the accrual method of accounting. Since dealers typically maintain inventories, they are not permitted to use the cash method. This results in dealers being required to recognize all of their sales revenue as income, forcing them to pay income taxes long before the customer has paid for the vehicle. Using an often-overlooked section of the tax code, dealers created RFCs to help alleviate the tax impact of this issue. The use of an RFC, because of the discounts taken, permits dealers to spread the recognition of taxable income over the life of the loan; thereby, more closely matching the tax burden to the cash flow. If dealers could use the cash method, the creation of the RFC would have been unnecessary.

The Act has expanded the use of the cash method so that businesses with gross receipts of less than $25 million dollars may be able to file for an election to use the cash method. This sounds like good news for many BHPH dealers, right? Not necessarily.

The current tax rules relating to the use of the cash method contain a snag for BHPH dealers that they may not have considered. These rules create “cash equivalency.” Under this definition, a dealer who receives an unconditional, assignable promise to pay from the customer, must recognize this as a cash equivalent; therefore, making the entire sale, once again, subject to income tax. The courts and the IRS have both reinforced this cash equivalency theory.

The Bottom Line: The expansion of the use of the cash method under the Act may not solve BHPH dealers’ problems. Accordingly, BHPH dealers must continue the use of RFCs until the IRS issues guidance changing the current rules or dealers risk seeing a significant increase in their tax bills. Contact Rex Collins with any questions you may have about the Tax Act and how it may impact your business.

An Open Letter to Business Owners:

Are you thinking about selling your business? Regardless of your reasons or circumstance, my first question as a professional advisor looking to help you would be, “Why do you think you are ready to sell now?” Your answer to that one question will likely give me the information I need to provide a helpful response.

Here are a few answers I’ve heard over the years of working with clients getting ready to sell their businesses:

• I was approached by a competitor who offered me a lot of money.

• I was approached by a private equity group who said they buy businesses like mine.

• My industry is changing and I don’t think I want to spend the time and money to keep up.

• My spouse has decided it is time for us to retire and start doing some things we have put off for years.

• My spouse has become ill and I need to be around to help.

• My children have no interest in taking over the business.

• I thought I’d shut the doors and sell off the assets, but figured I would see if anyone would buy it first.

• I want to use the proceeds from the sale of this business to start another business I am more passionate about.

• I just think now is the right timing for us to get a great price.

• There’s so much more that can be done with this business to benefit our clients, employees and community, but we just don’t want to risk our capital to expand at this stage of our lives.

These are just some of the answers I’ve heard, and they all provide important information, the exact reason or reasons why someone believes they are ready to sell. The sale of a business is one of the most significant transactions I can be involved in as an adviser looking to help you navigate this challenging transaction.

So what critical information will I get from your answer? Your timeline is one very important piece. Are you already talking with a potential buyer, investment banker or business broker? Or perhaps at the beginning of a two-to-three year exit plan? Regardless of where you are in the process, one of the best things I can do for you is let you know that HBK Corporate Finance will provide a no-obligation analysis of your business and talk with you about how to prepare, market, present and sell your business in a manner that keeps you in the driver’s seat.

Most of the time business owners feel they have very few, if any, people they can talk to about selling a business. In nearly every case they do not want their competitors, their customers, their employees or their community – and in some cases, even family members – to know of their plans. On top of all the financial considerations, selling a business can be emotional. Having someone to talk to about what to expect and how to lay out and implement a thoughtful plan can provide you with much-needed peace of mind.

Feel free to call me at 239-482-5522 or reach out to me at kveres@hbkswealth.com

Investment advisory services are offered through HBK Sorce Advisory LLC, doing business as HBKS Wealth Advisors. NOT FDIC INSURED – NOT BANK GUARANTEED – MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPAL – NOT INSURED BY ANY STATE OR FEDERAL AGENCY

Overview

The Tax Cuts and Jobs Act (the Act) created a new Business Interest Deduction limitation, effective for tax years starting after December 31, 2017. This new provision limits the deduction for business interest for all businesses, though an exception to the limitation applies for businesses who meet the gross receipts test, discussed below.

What is the Business Interest Deduction?

Businesses are allowed to deduct any interest paid or accrued on debt that is properly allocable to a trade or business, and is not considered investment income. Historically, this interest deduction has not been subject to many limitations.

Scope: Then and Now

Internal Revenue Code (IRC) Section 163(j) is the code section that provides for a limitation on the deduction for business interest. Prior to the Act, this provision had a limited application and only applied to U.S. corporations or U.S. branches of foreign corporations to prevent businesses from stripping earnings and avoiding U.S. taxation. The Act changed this code section to apply to all taxpayers and all debt, even if the debt arises from a related-party transaction.

The Limitation

The deduction is limited to the sum of business interest income, 30 percent of adjusted taxable income (ATI), and floor plan financing interest. ATI is generally taxable income, computed without regard to:

• activity that is not allocable to the trade or business;
• business interest expense or business interest income;
• depreciation, amortization, or depletion (for tax years beginning before January 1, 2022);
• net operating losses under Section 172; or
• the new 20% qualified business income deduction under Section 199A.

Floor plan financing interest is generally defined as interest paid or accrued on debt used to finance the acquisition of motor vehicles held for sale or lease, and which is secured by the inventory acquired.

If the limitation applies, the disallowed business interest will carry forward to the succeeding taxable year.

Gross Receipts Test Exemption – Small Businesses

There is an exemption from the limitation for small businesses with average annual gross receipts for the three taxable years ending prior to the taxable year at hand that is less than $25,000,000. However, taxpayers in controlled groups and partnerships may be required to aggregate gross receipts, so this should be considered when calculating whether or not the limitation should apply.

Carve Outs

Farming, real estate businesses, dealerships and certain public utility businesses successfully lobbied to avoid the application of this limitation. For dealerships, floor plan financing is fully deductible without limitation. However, these dealerships are excluded from 100% bonus depreciation on any of their assets.

Farming and real estate businesses may elect out of the new 30% limitation, but they will be required to use the Alternative Depreciation System (“ADS”) to depreciate their depreciable assets. Businesses using ADS are not eligible for 100% bonus depreciation. If the election is made, it is irrevocable, and ADS treatment will apply to all depreciable assets that are already owned or will be purchased in the future.

Real Property Business – Election Comparison

So, How does it Work?

Let’s use a hypothetical company, ABC Corporation, and assume it exceeds the small business exemption. ABC Corporation is in the business of residential rental property and, for illustration purposes, will not elect out of the business interest limitation. For the taxable year, ABC Corporation has the following income statement:

ABC Corporation can only deduct $30,000,000 of its $49,000,000 of net interest expense. The remaining $19,000,000 of disallowed interest expense will carry forward until used in a future year. The $19,000,000 disallowance is calculated as follows:

$50,000,000 interest expense – $1,000,000 interest income = $49,000,000 net interest expense

$49,000,000 net interest expense – $30,000,000 interest expense limitation = $19,000,000 disallowance

ABC Corporation will have taxable income of $45,500,000 if they do not elect out, but will have taxable income of $25,500,000 if they do elect out. Therefore, the election out is most beneficial in the current year where there is high business interest expense. However, electing out will likely decrease the depreciation deduction for the current year and future years, thus slightly increasing taxable income. The decision of whether or not an election out should be made should therefore take into account the impact on current and future depreciation.

Effect of Depreciation, Amortization, and Depletion on ATI and the Deduction

The larger the ATI, the larger the deduction. Starting in 2022, ATI will be reduced by depreciation, amortization, and depletion. Therefore, the deduction will likely decrease for many businesses at that point. Looking at our example above, if depreciation and amortization were included in the calculation of ATI, ABC corporation would have $52,150,000 of taxable income. The following shows this calculation:

ATI would be $74,500,000 because depreciation and amortization amount are not added back. ATI of $74,500,000 is then multiplied by 30%, which results in a limitation for business interest in the amount of $22,350,000. Taxable income ($74,500,000) is then reduced by the limitation amount ($22,350,000) to equal $52,150,000 of taxable income.

Conclusion

The new business interest expense limitation can be complicated, depending on the type of business and the business’s average gross receipts. For businesses that qualify to elect out of the limitation, it is important to compare the effects of the deduction limitation and the depreciation adjustments on overall taxable income for the current and future years. For businesses that will be subject to the limitation, planning should focus on the method of providing future financing since the limitation may restrict cash flow.

Please consult your tax advisor or a member of the HBK Tax Advisory Group to determine whether or not this limitation applies to your business.

Earlier this year, the Financial Accounting Standards Board (FASB) issued a revised lease accounting standard. The new standard – Accounting Standards Update (ASU) No. 2016-02, “Leases (Topic 842)” – may impact many contractors that lease vehicles, equipment or buildings.

FASB standards apply to all contractors that must maintain financial statements that comply with generally accepted accounting principles (GAAP). GAAP-compliant statements are required by lenders and bonding companies for most privately held contractors and public contractors, as well. The new financial reporting and accounting procedures are likely to affect some of the financial ratios stipulated in various types of loan covenants and surety agreements. Now is a good time to proactively plan in order to try to pre-empt potential problems.

The Changes

Under existing accounting rules, operating leases generally do not appear on a company’s balance sheet. This applies to all types of operating leases, including leases for vehicles, equipment, office machines, and office or warehouse space.

Under the new standard, you will be required to record the present value of the scheduled lease payments as a liability on the balance sheet. This liability would be balanced by recording the “right-of-use” value of the property or equipment as an asset. (There could be minor additional adjustments to the asset to reflect broker’s fees or other direct costs.)

The new standard allows an exception for short-term leases or those lasting less than 12 months that do not include a renewal option the lessee is “reasonably certain” to exercise. This means even short-term leases must appear on the balance sheet if they include extension options that meet these criteria.

The Impact

The most significant effect of the new lease accounting rules for most contractors will be their impact on commonly used financial metrics, particularly the working capital ratio and the debt-to-equity ratio. Many loan agreements and surety contracts require contractors to maintain these ratios at specified levels and to submit financial statements that demonstrate compliance. As a result, many contractors could find themselves out of compliance because of lease obligations that drive up their current liabilities and total liabilities.

Operating Leases v. Finance Leases

The existing standard makes a distinction between operating leases and capital leases, such as those that offer a bargain purchase option at the end of the lease. Because capital leases are generally regarded as a form of financing, they are already recorded on the balance sheet as a liability.

Under the new standard, this distinction is less important, since all leases over 12 months in duration will now appear on the balance sheet. The interest and amortization expenses for the two types of leases are handled differently, but these distinctions will not affect most contractors significantly. The new standard also changes the terminology somewhat, referring to finance leases instead of capital leases.

Other Related Matters

Many leases in the construction industry involve company owners who purchase property and lease it back to their businesses. The new lease accounting rules apply to such related party leases the same as third party leases, based on the “legally enforceable” terms of the lease agreement.

How to Prepare

For publicly traded companies, the new lease accounting standard will take effect for reporting periods beginning after Dec. 15, 2018. For privately held companies, the new standard goes into effect for reporting periods beginning after Dec. 15, 2019. Companies can begin applying the standard sooner if they choose.

Although the effective date seems to be far in the future, implementation of this standard will generally be overlapping with the implementation of FASB’s new revenue recognition standard. Because of this, companies should begin responding to this new standard sooner rather than later through the following methodology:

1. Understand the new standard and monitor changes in interpretation that are naturally expected to occur.

2. Create a cross-functional implementation team (e.g. finance, legal, operations, human resources, I.T.) and plan to implement the new standard.

3. Identify and communicate with stakeholders regarding the potential impacts to financial metrics, covenants, and other agreements (e.g. compensation).

4. Populate lease data and establish required judgments, estimates and accounting policy elections.

How HBK Can Help

HBK’s multidisciplinary team of accounting, tax and valuation professionals are available to assist in assessing how the new leases standard will impact you. Existing attest clients will receive training services on the technical aspects of the new standard as well as advice on project management and planning. Further assessment and implementation services are available to non-attest clients.

WHAT IS AN S CORPORATION?
S Corporations are “flow-through” tax entities, meaning income, deductions, credits and other activity are allocated to shareholders to be reported on their individual tax returns. When shareholders are allocated losses from an S Corporation they can use the losses to offset income from other sources — if the losses pass three tests, the first two of which, “stock basis” and “at-risk” limitation rules, are the subject of this article. Both are based on how the loss was funded.

The goal of stock basis and at-risk limitation rules is to limit a shareholder’s use of losses to those that have been personally funded by the shareholder. S Corporation shareholders can take losses to the extent of their personal investment in the corporation. Losses funded by loans from unrelated parties or loans from the shareholders of funds that are not at risk cannot be deducted. Instead, the losses are suspended and carried forward until the shareholder increases their stock basis and amount at risk.

TEST NO. 1: STOCK BASIS
A shareholder’s initial stock basis is determined by how they acquire their interest in the S Corporation: the money and other property a shareholder contributes to start the corporation or the amount paid to purchase shares in the corporation. If S Corporation shares are gifted, the recipient is also gifted the donor’s basis in the shares. The basis of inherited shares is adjusted to the fair market value at time of the decedent’s death.

From the initial basis, a shareholder’s basis can be increased by capital contributions, personal loans to the corporation, and income allocated to the shareholder; or decreased by distributions, repayment of loans from the shareholder, and losses allocated to the shareholder. If a shareholder has stock basis in excess of their loss at the end of the tax year, they pass the first test in determining whether or not they can deduct the loss.

TEST NO. 2: AT-RISK LIMITATION
To deduct an S Corporation loss, the taxpayer must also be sufficiently at risk. Simply stated, a shareholder’s amount at risk is the extent to which they have dipped into their own pocket to fund operations. In a partnership, partner tax basis includes their share of the partnership debt, including loans from third parties and banks. This often results in differences between partner basis and at-risk basis because the partners have basis for partnership debt but are not at risk. In an S Corporation stock basis and at-risk basis are often the same because shareholders typically do not receive stock basis for their share of S Corporation debt. There is one significant exception: an S Corporation shareholder’s basis includes money loaned by the shareholder to the corporation.

While an S Corporation shareholder receives stock basis for loans made to the corporation they are not always at risk for the debt. A shareholder is only at risk for loans it makes to the corporation if the shareholder is at risk for the funds loaned to the corporation. We often encounter scenarios where a shareholder personally borrows money and loans the proceeds to the S Corporation, a so-called “back-to-back” loan. A shareholder is not at risk for a back-to-back loan unless they are personally liable for the repayment of the loan, or if they have pledged property other than S Corporation property or their S Corporation stock as security for the loan. If the loan to the shareholder is “nonrecourse,” meaning they are not personally liable for the repayment, they will not receive at-risk basis by loaning the proceeds to their S Corporation.

If you are a shareholder in an S Corporation that has incurred a loss during the tax year, and you pass the stock basis and at-risk tests, you’re two-thirds of the way home in terms of being able to deduct your losses.

This is the first in a series. Read Can You Deduct Your S Corporation Losses? Passive Activity Loss Rule

The 2015 PATH Act made the R&D tax credit permanent and expanded benefits to many taxpayers. Historically, many qualifying taxpayers have failed to take advantage of the credit. This is, in part, due to misunderstanding whether their activities qualify for credit. In addition, many taxpayers are simply unaware that the credit exists. The R&D tax credit has been in the Internal Revenue Code since 1981. It has survived all major overhauls of the Code since its adoption.

Considering the expanded benefits (outlined in this article) and the potential of the credit to offset taxes while also maintaining a deduction for these costs, taxpayers should consider how it can be applied to their businesses.

Expanded benefits due to the PATH Act are twofold. Businesses and certain startups with less than $5 million in annual revenue can now use the credit against their payroll taxes, assuming they have had employees engaged in R&D for five years or less. Under the new law, the maximum benefit an eligible company is allowed to claim against payroll taxes each year is $250,000. The payroll tax offset is available to companies that meet the following qualifications:

• Generated gross receipts for five years or less
• Less than $5 million in gross receipts in 2016, and for each subsequent year for which the credit is elected
• Conducted qualifying research activities

In addition, qualified small businesses with less than $50 million in gross receipts are now able to use the R&D tax credit to offset the Alternative Minimum Tax (AMT). Prior to 2016, the AMT often limited the benefits of the R&D tax credit.

Many businesses fail to take advantage of the R&D credit. If your business performs any of the activities listed below, you are likely performing qualifying R&D activities:

• Improving product quality
• Developing second generation or improved products
• Developing products through use of computer-aided design tools
• Designing and/or developing tooling and equipment fixtures
• Optimizing manufacturing processes
• Designing manufacturing equipment
• Prototyping and modeling three-dimensional products
• Designing, evaluating and/or developing cost-effect operational processes or alternatives
• Performing alternative material testing
• Integrating new materials for improved product performance and manufacturing processes
• Evaluating and determining the most efficient flow of material
• Designing, creating and testing product prototypes
• Increasing manufacturing capabilities and production capacities
• Achieving compliance with changing emission regulations

Considering the expanded benefits, the underutilization, and the permanent nature of the credit, now is the perfect time to consider this opportunity. Please contact David Downie with questions on the R&D Credit and its many potential applications.

Since President Donald Trump was on the campaign trail, there have been varying reports regarding his overall tax plan. From the beginning, there has been a lack of detail, which has lead to uncertainty in tax planning for individuals and businesses alike.

To add to the confusion, Representative Paul Ryan (R-WI), the speaker of the House of Representatives, has pushed forward his own version of tax reform under his overall plan titled “A Better Way.” While some provisions of the Trump plan are similar to the Ryan plan, they are by no means the same.

In early February, President Trump indicated that a major tax announcement will be made within the coming few weeks. What this will look like is anyone’s guess, but it’s likely to have many of the same provisions that President Trump has previously provided.

A large focus of his plans have been a decrease in tax rates, resulting in a top income tax rate of 33 percent for individuals and 20 percent for businesses, and an overall simplification of the tax code. President Trump also indicated that major tax reform will be achieved through the budget reconciliation process.

Budget Reconciliation is a Senate legislative process created by the Congressional Budget Act of 1974. The process provides a faster method of instituting legislation concerning taxes, spending and debt limits. Legislation passed through the reconciliation process is not subject to filibuster in the Senate – meaning that the legislation can pass the Senate with a simple majority vote, rather than 60 votes that would be necessary to avoid a defeat through a filibuster. Legislation passed through this process is subject to a 10-year limitation.

The simple answer here is that it provides an easier way of enacting tax reform legislation without having to compromise with the Democrats on specific tax provisions. The Republican Party currently holds a majority in both the House and the Senate. To pass the House, tax reform legislation will simply need a majority vote.

However, in the Senate the Republican Party only controls 52 seats. This means, to avoid a filibuster, President Trump would need to get the support of eight Democrats and/or Independents. This is not likely to happen without significant compromise.

Again, any legislation passed through this process will be limited to a 10-year period. That means this type of tax reform is simply a patch, and 10 years down the road we’ll be dealing with a new tax overhaul with a new administration and new agenda. This will continue to create uncertainty in planning for both individuals and businesses.

Right now, the best strategy is to wait and see what happens, and continue to utilize the same planning techniques that have been available in the past. While some form of change is likely to occur, this change will probably not affect the 2017 tax year. Many believe tax reform legislation may pass in the fall of 2017, which will give us plenty of time for tax planning before the year ends. As new details continue to come out, we’ll keep our clients informed.

The U.S. Department of Transportation (DOT) has released their 2017 U.S. deficient bridge report and analysis prepared by the American Road & Transportation Builders Association (ARTBA). The report inventories more than 55,000 structurally deficient U.S. bridges, 1,900 of which are located along the Interstate Highway System. Within the report, ARTBA’s Chief Economist, Dr. Alison Premo Black, notes “the inventory of structurally-deficient bridges has declined 0.5% since the 2015 report. At that pace, it would take more than two decades to replace or repair all of them.” The report has in-depth and state-specific information on structurally-deficient bridges, national bridge inventory totals and proposed bridge work by location. The full context of the report and its analysis can be found here.

This sweeping infrastructure initiative provides opportunities for business owners in many areas including bridge construction, painting, maintenance and several other related industries. The professionals at HBK CPAs & Consultants (HBK) can help navigate the potentially complicated process of working on governmental contracts by offering advice on how to:

1. Acquire, analyze and organize key financial information
2. Understand “true” contract costs and how to use them to assist in bid price determinations
3. Comply with state and federal licensing requirements
4. Improve working capital and help enhance bonding limits by offering directives for discussions with surety companies

For more information and further details about how the construction industry specialists at HBK can help your business, please contact either Michael Kapics at mkapics@hbkcpa.com or Nicholas Odille at nodille@hbkcpa.com.

In August 2016, the IRS has released proposed regulations that would drastically reduce the tax advantages of certain estate planning strategies many dealers use. If enacted, the new regulations would lower or eliminate estate and gift tax discounts (those allocated for lack of marketability and lack of control) that previously were permitted on the transfer of interests in family-owned corporations, partnerships, and LLCs. For many family business owners, this will mean paying much higher gift and estate taxes when transferring business ownerships to heirs. These regulations could possibly take effect early this year.

In fall 2016, the Dealership Industry Group at HBK CPAs & Consultants (HBK) conducted a webinar outlining the details of these proposed regulations and offered potential steps dealers could take to mitigate their impact. Since then, Donald Trump was elected President, which is likely to change the course of many rules, policies and laws, including these proposed regulations. In fact, in light of President Trump taking offices, it seems unlikely that these regulations will even be finalized.

The Trump administration is proposing changes in the estate tax arena though it is too early to tell whether or not these changes will be enacted.

Still, even though it’s always prudent to have a strategic estate and succession plans in place, the urgency for many dealers to complete family business transfers quickly has waned.

HBK will alert our clients, colleagues and associates of breaking news related to these proposed regulations. Contact us with questions on this or related issues, we are here to help.

Over the years the Internal Revenue Service has issued regulations and notices which deal with W-2 reporting for owners of businesses.  These notices simply reinforce advice that we have given our clients in the past and it is clear that you will need to take steps to comply with this guidance.  Additionally, we want to remind you of the reporting requirements concerning company-provided fringe benefits and personal use of company-provided vehicles. Special rules apply to qualified demonstrator usage; accordingly, we have provided a separate memo relating to these rules.  To this end, we are providing the following general information.  Should you, your office manager or your payroll clerk have any questions, please give us a call.

Taxable fringe benefits are reported on the employee’s Form W-2 and are generally subject to both federal income tax and FICA withholding requirements.  You may also identify the total value of the fringe benefits in Box 12 or Box 14, depending on the type of benefit.  Following is a list of some common fringe benefits that should be included in employee’s Form W-2.  Obviously, not every item will apply to you.

All Employees

1. Employer-provided parking in excess of $255 per month.
2. Employer-provided transportation (i.e., transit passes) in excess of $255 per month.
3. Cost of providing group-term life insurance coverage in excess of $50,000 (nondiscriminatory plans only).
4. Cash payments under a Cafeteria Plan.
5. Personal use of company-provided vehicles (see attached methods for valuing this benefit).
6. Employer-provided Child or Dependent Care Services in excess of $5,000 or the employee’s earned income.
7. Expense reimbursements and advances if the employee is not required to provide substantiation and/or return any excess advance.
8. Payments for health, disability, life or accident if not paid in connection with an employee benefit plan or paid under a discriminatory plan.
9. Education expenses paid for courses that are not required for the employee to perform his job duties.
10. Payments under an Education Assistance Program that exceed $5,250.
11. Nonqualified moving expense reimbursements (reimbursements for expenses other than cost of moving household goods and travel expenses, excluding meals, from old residence to new).  Qualified moving expenses are reported on the W-2 as nontaxable benefits.
12. Any employer-provided benefit that is both business and personal to the extent of the personal portion.  Expenses considered personal in nature includes, but are not limited to, payment of the employee’s share of FICA tax, club membership dues, travel expenses for employee’s spouse, etc.
13. Premiums paid on group permanent life insurance.
14. Awards and prizes (non-cash), i.e., employee achievement awards, unless they pertain to length of service and safety and do not exceed specified limits (generally $400).
15. Employee Contributions to Archer Medical Savings Accounts or HSA’s.

More than 2 Percent Shareholder – Employees of S Corporations

In addition to the taxable fringe benefits listed above, more than two percent shareholder – employees must also include the following benefits in income.

1. Premiums paid to an accident and health plan for the employee, spouse and dependents.
2. Premiums paid for any amount of group-term life insurance coverage.
3. Cost of meals and lodging furnished for the convenience of the employer on the employer’s premises.
4. Cost of employer-provided group legal, dependent care and educational assistance programs.
5. Cost of benefits provided under a Cafeteria Plan.
6. Disability insurance premiums if paid under a benefit plan provided to employees.

The company is entitled to deduct these expenses in determining its taxable income.  Any of the above expenses, with the exception of items B and C, includable in the shareholder-employee’s W-2 are not wages subject to FICA and FUTA tax if they are paid under an employee benefit plan established for the company’s employees.

In determining whether a shareholder owns more than a 2 percent interest, stock owned by any lineal descendent (i.e., children, parents, spouse, etc.) is considered owned by the shareholder – employee.

The above list of taxable fringe benefits is not meant to be all-inclusive.  There may be other benefits not listed and specific to your company that should be included in the employees’ W-2.  There may also be exceptions available that could result in some of the above benefits not being taxable to employees.  If you need further clarification or additional information on any of these fringe benefits, please do not hesitate to call me.

Enclosures
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