Fringe Benefits, W-2 Wage Limit and the IRC Sec 199A Deduction

UPDATE 1/9/19

I wrote the below items before looking at Notice 2018-64, which spelled out more of what constitutes wages for the IRC Sec 199A deduction.

Under this, you can choose 1 of 3 different methodologies to calculating wages

  1. UNMODIFIED METHOD - lesser of box 1 or box 5

  2. MODIFIED METHOD

    BOX 1 - the stuff in box 1 which isn’t wages subject to federal withholding + 12D, 12E, 12F, 12G, and 12S

  3. TRACKING METHOD

    *am confused by this method as it sounds a lot like #2, but maybe this was meant for fiscal year taxpayers, because this is just saying look at the employees wages subject to fed withholding and add those box 12D, 12E, 12F, 12G, and 12S stuff*

Here’s my original post without considering Notice 2018-64. I just updated the final bit about the medical insurance premiums for a more than 2% shareholder, as I think the answer is more clearly “no” at this point.

IRC Sec 199A(b)(4) Wages, etc (it’s great when the law uses “etc” to try and explain something)

IRC Sec 199A(b)(4)(A) In General “The term ‘W-2 wages’ means, with respect to any taxable year of such person, the amounts described in paragraphs (3) and (8) of section 6051(a) paid by such person with respect to employment of employees by such person during the calendar year ending during such taxable year.”

IRC Sec 199A(b)(4) also has a (B) and (C), but (B) limits the wages only associated with that qualified business. (C) is you have to file W-2 with the SSA. 

Back to 199A(b)(4)(A), Okay, fancy way of saying W-2 wages paid in the tax year. okie dokie. moving on.

Paragraphs (3) and (8) of section 6051(a)

6051(a)(3) “The total amount of wages as defined in Section 3401(a)”

6051(a)(8) “The total amount of elective deferrals (within the meaning of section 402(g)(3)) and compensation deferred under section 457, including the amount of designated Roth contributions (as defined in section 402(A)” *I’ll skip over this part and assume it generally just refers to employee’s elective contributions to a retirement plans*

So first, what is Section 3401(a), “For purposes of this chapter, the term “wages” means all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration (including benefits paid in any medium other than cash; except that such term shall not include remuneration paid to…-” then it lists 14 categories who this doesn’t apply to including non resident aliens, active duty US military, ministers/priests, people paid de minimis amounts, etc. ->I’m hoping/assuming most of these won’t apply to most clients.

The question, I’m currently facing is

(1) is the personal use of the company car, is that includible W-2 wages, for purposes of the Sec 199A deduction?  (I’m using personal use of the company car, but this really applies to most fringe benefits which are taxable to employees, regardless of whether the employee is an owner or not.  So if you included the parking in the employee’s W-2, it would fall into this category) 

(2) is medical insurance paid for employees includible in the W-2 wages, for purposes of the Sec 199A deduction?  (Same as the personal use of the company car, this is referring to all fringe benefits which are non-taxable to regular employees but taxable to more than 2% owners if they work for the company)

Personal Use of the Company Car

The personal use of the company car is I believe taxed under IRC Sec 61 “Gross income defined”, but the only item covering “fringe” in the Internal Revenue Code seems to be "IRC 61(a)(1) Compensation for services, including fees, commissions, fringe benefits, and similar items”. The regulations on Reg 1.61-21 Taxable of fringe benefits just seems to clarify how to calculate the personal use of a company owned car.

IRC Sec 61 doesn’t mention wages. My guess (since I’m still new to the tax world) is IRC Sec 61 is defining the “remuneration” word in IRC Sec 3401(a), but that’s just a guess. It’s not as straightforward had the code said “remuneration” is defined as gross income under IRC Sec 61. Maybe someone else can find the more direct line from IRC Sec 61 to IRC Sec 3401(a). 

My guess on this is that personal use of the car by non-owner employees, is totally includible in the W-2 wages limitation for Sec 199A.  That it’s taxable to the employee as wages and subject to the both withholding for income tax and payroll taxes.  It also seems to be one of those fringe benefits which is clearly in line with the IRC Sec 3401(a) words “including benefits paid in any medium other than cash” 

However, for S Corporation owners, it’s a little more tricky.  IRC Sec 1372 provides that S Corporation shareholders who own more than 2% of the S Corporation are treated like partners in a partnership, which honestly makes this whole thing with IRC Sec 199A really weird.

What’s weird is taxable fringe benefits to partners are treated as guaranteed payments, and if there’s anything we know about IRC Sec 199A is guaranteed payments are the kiss of death.  This is because guaranteed payments reduce the qualified business income, but also do not increase your W-2 wages, for purposes of the IRC Sec 199A deduction  In an S Corporation, while the reasonable compensation to the owner/employee reduces the qualified business income, at least it increases the W-2 wages, for purposes of the IRC Sec 199A deduction, so there’s something there. 

But S Corporation owners don’t receive “guaranteed payments” they either receive a W-2 or a 1099-misc (depending on employee status).  And partners in a partnership don’t receive a W-2 (usually), there’s could be some weird exceptions, but that’s a whole other ball game. 

I think this falls into a gray area, but I’d ultimately side with including this in your W-2 wages for the Sec 199A deduction.  The reason is the personal use of the vehicle is taxable for both non-owner employees and owner employees, so this isn’t as much using the section about 2% S Corporation shareholders, because it doesn’t really matter if the employee is an owner or not.  But this one isn’t a clean cut answer.    

Medical insurance for the employees (the non-owners/shareholders)

I think this one is clearly “no” because the health insurance for employees is clearly a non-taxable fringe benefit, not includible on the W-2.  Also, if you revert back to the W-2 wage rule, for the original 199 deduction (which is now deceased), it described wages as “wages that are subject to withholding, plus most elective deferrals”. 

What’s interesting is as far as I can tell “elective deferrals” do not include amounts put into an employees Section 125 Cafeteria plan.  So employees, if offered Sec 125 plans, can reduce the employer’s W-2 wages for purposes of the Section 199A deduction. 

Medical Insurance Paid on Behalf of 2% more owning S Corporation Shareholders

Medical insurance paid by the company of a more than 2% S Corporation shareholder is added to the W-2, because it falls into that IRC Sec 1372 category, where the S Corporation shareholder is treated like a partner in a partnership for certain fringe benefits, one of these being medical insurance.

But on the W-2, this is just added in Box 1, but is not included for the calculation of payroll taxes (meaning not box 3 and box 5). 

Is this medical insurance added to box 1 for a more than 2% shareholder subject to federal withholding? I think the answer is “no”, which would mean it’s not includible in the wage limitation for IRC Sec 199A

Conclusion

1)      Personal use of the company vehicle by non-owners – Includible in the W-2 Wages for Sec 199A purposes

2)      Personal use of the company vehicle by non-owners – Probably includible in the W-2 Wages for Sec 199A purposes

3)      Medical insurance for the non-owners – Not includible in the W-2 Wages for Sec 199A purposes

4)      Medical insurance for the 2% S Corporation owners – Probably not.