Fringe benefits include items such as accident and health insurance, medical savings accounts, group term life insurance, salary continuation plans, reimbursements for educational expenses, dental insurance, death benefits, day care programs, supplemental unemployment benefits, “cafeteria plan” programs, and others. As with employee retirement benefit plans, the tax treatment of fringe benefits is a highly technical area. Accordingly, it is recommended that the advice of competent counsel be obtained prior to structuring such plans. The following paragraphs discuss the tax treatment of providing fringe benefits to owners of the business. The cost of providing fringe benefits to employees generally will be a deductible business expense if reasonable in amount and in compliance with federal and state tax codes and other statutory requirements. In some cases the benefits may be taxable to the employee and subject to income tax withholding.
Sole proprietors generally may not deduct as a business expense the cost of obtaining fringe benefit items for themselves, although items such as day care for the proprietor’s children may be eligible for a tax credit if they otherwise meet IRS requirements. For federal tax purposes sole proprietors, after 2003, may deduct up to 100 percent of the cost of medical insurance premiums paid for themselves, assuming IRS requirements are met. Note that this issue is frequently the subject of legislation in Congress, so anyone interested should monitor developments. Note that for Minnesota income tax purposes, in some cases amounts paid by a sole proprietor for health insurance are subtracted from federal taxable income for purposes of computing Minnesota taxable income. That calculation is made on Schedule M-1H to a sole proprietor’s Minnesota income tax return. Partnership. Working partners of a partnership are considered self employed individuals, and are subject to the same rules on deductibility of fringe benefits as sole proprietors.
The C corporation may deduct the cost of providing fringe benefits to all employees, including shareholder employees. To be deductible, the fringe benefit plan must meet requirements of the federal and state tax laws, including nondiscrimination in favor of executive or highly compensated employees. Employee health plans also must comply with applicable state statutory requirements to be deductible for Minnesota income tax purposes.
An S corporation may deduct the cost of providing fringe benefits that it pays to all employees, including shareholder employees. However, the cost of fringe benefits paid for employee shareholders who own more than two percent of the company’s stock must be included in the income of the shareholder. Typically, this is reported on the shareholder employees’ Form W-2 in addition to their normal salary.
CREDITS: This is an excerpt from A Guide to Starting a Business in Minnesota, provided by the Minnesota Department of Employment and Economic Development, Small Business Assistance Office, Twenty-eighth Edition, January 2010, written by Charles A. Schaffer, Madeline Harris, and Mark Simmer. Copies are available without charge from the Minnesota Department of Employment and Economic Development, Small Business Assistance Office.
This is also part of a series of articles on How to Pick the Right Business Entity Type. These articles help you select the right business type for your circumstances.
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