Q:

Subject: looking for more tax free employee benefits

My husband has a small business formed as an S corp. He is 100% shareholder. There are two employees, himself and myself. There is a retirement plan and health insurance plan. On my husband’s W2 we must report as taxable income the health insurance premiums. Then we take a deduction on the 1040 for self-employed health insurance premiums.

We’d like to have more employee benefits, i.e.; a cafeteria plan to handle out of pocket medical and child care expenses.

A local CPA recommended that we do the following:

Keep the S corporation and set up another corporation as a C. The C would manage payroll, payroll taxes, employee benefits (cafeteria plan) retirement and health insurance plans. The S would pay a “Management Fee” to the C. Management Revenue in the C would fund payroll, taxes, benefits, retirement and health insurance. C corporation net income would as close to $0.00 as possible each tax year.

How does this sound to you? Is this a strategy that the IRS will approve of?

Please explain what expenses a C corporation can deduct that an S cannot?

Sincerely,

A:

It sounds as if you have a good creative thinking tax advisor there.  That is a strategy I have set up countless times over the years.

As I described in my article comparing S and C corps, there are much more generous tax free benefits available to shareholders in C corps than with S.

Rather than list out every type of fringe benefit, I’ve attached a copy of the table comparing the treatment of fringe benefits in different entities from the Small Business QuickFinder.

I hope this helps you understand the differences.  

Kerry Kerstetter

Update: 

The following article covering this same issue was included as part of the most recent Intuit newsletter for accounting pros:
Taking Cash Out: More Tax-Favored Fringe Benefits

 

 

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