Sense with Cents

Many do not fully consider the ramifications of IRS Notice 2008-1. (Not everything belongs in payroll — see Minister/Clergy Housing Allowance for an item that should stay out entirely. This one, however, must be in.) The notice exists to ensure deductibility — in order for a greater-than-2% S-Corp shareholder to deduct health insurance premiums, the amount must be reported as wages on their W-2, Box 1. The required action is straightforward enough. The ramifications are not.

By requiring the amount to be reported as wages, it becomes wages for all purposes — even though eventually it is not taxed for many items later. Most stop reading the notice once they see "include in Box 1." The deeper implication is what matters.

Early on, I was opining that the amount, as wages, must be constructively reported proportionally on each paycheck — not dumped in as a lump sum at year end. The taxpayer could then adjust their W-4 to avoid over withholding. Not reporting this constructively is a form of wage shifting, which the IRS frowns upon. This position is more widely accepted now.

The amount can be paid by the corp, but for compliance — and to retain the tax benefit — it must be constructively included as wages, in a proportionate amount, on every paycheck. Do not read the IRS notice for only what actions are required. Note that the amount is to be considered wages. Once it is wages, constructive reporting is triggered — the same as an hourly amount would be. If you would not lump-sum report an employee's hourly pay at year end, you should not lump-sum report this either.

The safe and proper method: calculate the annual benefit, divide by paydays per year, and include that amount on every paycheck (much like any other wage item — see FLSA OT (QOC) and Agricultural Employees for another example of W-2 reporting that is more complex than it appears). Then, in late November, review the amount reported against the actual insurance cost for the year, leaving December to make any final adjustments so the proper amount is reported for the year.