Amy, Bob, and Carol want to discuss forming an S corporation instead of a partnership to operate a marina in Florida. They wish to have equal ownership in the business entity. Amy can contribute $400,000, and she is a boat mechanic. Bob has management expertise in running a marina, and he has five acres on the Intracoastal Waterway that he can contribute. Carol has experience running an office, and she has $300,000 in cash and office furniture and equipment worth $50,000. The three partners in this endeavor are interested in providing health insurance, life insurance, and dental insurance for each owner.
In your report, explain whether there are any tax advantages of having the business provide employee benefits for owners as well as other employees. What are some options that should be considered to fairly compensate each of the owners for what they are contributing and for the work they will do running the business?
As a small business, Ann, Bob, and Carol’s business is qualified to elect for a S corporation. Generally, shareholders are compensated with ordinary income or loss and separately stated items according to the rata of stock held by each of them on each day of the S marina’s tax year (IRC section 1367).
In accordance to IRC section 132, health insurance, life insurance, and dental insurance are treated as fringe benefits for tax purposes. According to IRC section 1372, a S corporation shall be treated as a partnership and adopt partnership rules for fringe benefit issues, and any individual on any day during the taxable year of the S corporation holding more than 2% of the corporation’s stock/voting power shall be regarded as a partner. Therefore, there are no tax advantages of providing health insurance, life insurance, and dental insurance for each owner, as Ann, Bob, and Carol all hold more than 2% of the corporation’s stock, and they have to include the benefits as part of their taxable income (IRS Publication 15-B).
There are generally three sources of a S corporation’s gross receipts, including the services provided by shareholders, services provided by non-shareholder employees, and capital and equipment contributed by shareholders. If a shareholder contributes no gross receipts for the corporate through his/her service, he/she should not be awarded with additional compensation besides ordinary benefit distribution (Internal Revenue Service [IRS], 2019).
Based on what each of the owners contributed, Amy should be compensated for her mechanic service offered to the S corporation, along with benefit distribution for her $400,000 capital investment; Bob should also be compensated for his managerial talents, besides to the allocated benefit distributions for the five acres waterway he contributed. Given that Garol provides only $35,000 capital, including cash, furniture and equipment, she might only receive distributions based on the rata of her capital contributed to the S corporation. Similar considerations should be taken as for compensating the work they will do running the business. Available compensations might include medical insurance premium paid by S corporation, and health insurance under the Affordable Care Act.