If you have a C corporation, it’s important to know how to take advantage of the many tax-free fringe benefits available to employees
There are many benefits of creating a C corporation if you run a business. A significant one is that the company is separate from its members so that they are taxed separately. Another advantage is the tax-free fringe benefits, which are tax-deductible for the company and tax-free for the shareholders or employees.
This article explains who qualifies for these tax-free fringe benefits and details about each type.
While the C corporation can deduct certain fringe-benefit expenses, the non-owner employees are the individuals who truly get to take advantage of the “tax-free” description.
These benefits commonly apply to C corporation shareholders or employees. But they also apply to an S Corporation shareholder or employee if it is a large organization, and the employee owns less than 2 percent. These individuals then fall into the same category as a non-owner employee.
Getting the best of both worlds
An effective strategy for sole proprietor physicians, for example, would be to form:
- An S Corporation for 1099 income or medical practice income
- A C Corporation for administrative or management services provided to the S Corporation
This allows you to get the best of both worlds since both types of companies have some tax-free benefits. In addition to the C corporation tax-free benefits we detail later, examples of S corporation tax advantages include:
- Vehicle expenses
- Home-office expenses
- Per diem meals and travel
Another plus of using both structures is that you can use the C corporation as a shifting vehicle for income from the S corporation. This enables you to take advantage of the lower 21% tax bracket.
What is a fringe benefit?
A fringe benefit is a form of payment that can be excluded from an employee’s taxable income for the performance of services. The recipient can be an employee, independent contractor, partner, or director within C corporation.
A cafeteria plan is a benefits plan where staff members can choose to contribute a specific portion of their income to benefits before taxes are deducted. These could be health insurance, health savings accounts (HSAs), a 401(k), or group-term life insurance coverage. Cafeteria plans allow employees to choose between cash and other benefits. Note that this plan isn’t necessary if you’re the only employee of a C corporation.
All fringe benefits are normally taxable to the recipient, but tax law excludes some of them that are covered in detail below.
Types of tax-free fringe benefits for C corporations
Certain healthcare costs are tax-free fringe benefits, including:
- Out-of-pocket healthcare expenses
- Contributions to accident or health insurance
- Long-term care insurance
- Archer Medical Savings Accounts (MSAs)
- Health Savings Accounts (HSAs)
The tax-free contributions to each of these are limited to $5,250 for a single filer and $10,600 for a family.
Group-term life insurance coverage is also a healthcare-related fringe benefit of up to $50,000 in death benefit for an employee and up to $2,000 for an employee’s spouse and each dependent. Finally, this benefit would also apply if an employee has become sick from COVID-19 and isn’t able to work.
Education costs such as a degree program or continuing education courses are also tax-free fringe benefits. However, courses involving sports, games, or hobbies do not qualify. Classes must be related to the business or part of a degree program. The benefit is up to $5,250 per employee per year.
A new tax-free fringe benefit that only applies to 2020 is student loan forgiveness, up to $5,250 per employee.
Childcare costs such as afterschool care and daycare are included in the classification. In addition, adoption assistance is provided for highly compensated employees (making over $125,000 typically), or shareholders or employees owning less than 5 percent of the company.
This benefit also covers dependent care assistance in the amount of the lesser of $5,000 per year of benefits or the employee’s or spouse’s earned income.
If there is an athletic facility or gym on the employer’s premises used by employees, their spouses, or their dependents, it is also considered a tax-free fringe benefit. This could be a swimming pool, tennis court, or fitness equipment. The depreciation of equipment and any necessary land improvements or maintenance costs can also be included.
Specific payments from C corporation are tax-exempt during this crisis, including:
- Payments for personal, family, living, or funeral expenses as a result of COVID-19
- Payments received for reasonable and necessary expenses for the repair or rehab of a personal residence or of repair or replacement of contents, if they are attributable to COVID-19
For example, if a home office had to be built because of COVID-19 social-distancing restrictions, it would apply.
There are additional expenses covered that may be incidental for physicians but could add up to a substantial sum. Examples include:
- Incidental meals
- Achievement awards
- Employer-provided cell phones
- Employee discounts
- Employee stock options
Important note: as of 2018, moving expenses are no longer considered a tax-free fringe benefit for employers.
Remember that each of these types of tax-free fringe benefits is excluded from income tax, and also Medicare, FICA, and unemployment taxes. Depending on your income tax bracket, you could potentially save something like 50 to 60 percent, contingent on where you live.
Record-keeping and reporting requirements
Finally, you have to keep accurate records throughout the year to take advantage of these benefits. This includes supporting expense or cost documentation and payroll tax reporting, where applicable. For example, you need to track all childcare or medical expenses that will need to be reimbursed. Some benefits, like contributing to a 401(k) or an HSA plan, also have payroll tax reporting requirements.
If you decide to set up a C corporation to take advantage of these benefits, work with a professional who can help you identify all options, and fulfill all documentation requirements.
Physician Tax Solutions supports busy medical practitioners with proactive strategies and full-service tax preparation services that dramatically reduce tax bills. Contact us online or by calling 1-855-693-7829 to start saving today.