The BNA Tax and Accounting Center is the only planning resource to offer expert analysis and practice tools from the world's leading tax and accounting authorities along with the rest of the tax...
By Gerald S. Deutsch, Esq.
Glen Head, NY
The Internal Revenue Code defines a “Cafeteria Plan” as a written plan under which all participants are employees, and the participants may choose among two or more benefits consisting of cash and “qualified benefits.” A “qualified benefit” is a benefit which is not includible in the gross income of the employee. It's a good tax advantage for the recipient - instead of getting taxable cash, the employee is getting a non-taxable benefit. In addition, the cost is deductible by the employer.
A cafeteria plan is subject to certain rules and restrictions, including that it cannot discriminate in favor of highly compensated employees.
Of course, a partner in a partnership cannot be covered by a cafeteria plan because a partner is not considered an employee. If, however, the partner's wife works for the partnership, she would be an employee, and she could participate in the plan. But what about a shareholder's wife in an S corporation, who is also an employee of the corporation?
The cafeteria plan regulations that were released in 2007 make it clear that more than 2% shareholders in an S corporation cannot be covered under their corporation's cafeteria plan. Those regulations define a more than 2% shareholder by using the strict attribution rules that consider stock owned by spouses, children, etc. as being owned by the “employee.”
These regulations affirmatively provide that participation in a cafeteria plan is one of the fringe benefits that the Internal Revenue Code where the partnership rules restricting fringe benefit for partners will also apply to a more than 2% shareholder of the S corporation. In addition, the attribution rules specifically will apply, which regard stock owned by spouses, children, etc. as being owned by the employee.
Note that no such attribution rule exists for partnerships. The wife of a partner is not considered to be a partner. For some reason - or perhaps no reason - S corporations are being treated more harshly than partnerships here.
So if a partner in a partnership has a wife that is an employee of the partnership, and the partnership establishes a cafeteria plan, it would appear that the wife would be able to participate in that cafeteria plan based on her being an employee.
If, however, the entity is an S corporation, and the husband, instead of being a partner was a more than 2% stockholder in the S corporation, his stock ownership would be attributed to his wife. Under the cafeteria plan regulations, she thus would not be eligible to obtain the advantages of the cafeteria plan. If she participated in the plan, the benefits would be taxable to her.
This seems to be another example of where an LLC might be a better vehicle than an S corporation, especially if it is contemplated that family members of a 2% owner will be employed in the business.
For more information, in the Tax Management Portfolios, see Raish, 397 T.M., Cafeteria Plans, and in Tax Practice Series, see ¶5940, Cafeteria Plans.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to email@example.com.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to firstname.lastname@example.org.
Put me on standing order
Notify me when new releases are available (no standing order will be created)