S-Corp, HSA, and QBI

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plutoblackhole
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S-Corp, HSA, and QBI

Post by plutoblackhole »

[2022 thread bumped in 2024 --admin LadyGeek]

Hi Bogleheads,

There's a lot of posts about how you can add HSA reimbursements to a 2% shareholder's W2, which effectively increases the shareholder's compensation without increasing FICA tax. For example, here: viewtopic.php?p=4580304#p4580304
Spirit Rider wrote: Wed Jun 05, 2019 11:49 pm You must do all of the following steps:
  1. The S-Corp must contribute to or reimburse your contributions to an HSA.
  2. The S-Corp includes the HSA contribution on Form 1120S, Line 7 Officer Compensation.
  3. The S-Corp reports the HSA contribution on the shareholder-employee's W-2 Box 1, but not Boxes 3 & 5 and Box 14 not 12.
  4. The S-Corp shareholder-employee claims the HSA deduction on their personal Form 1040, Schedule 1, Line 25.

This is similar to the way that health insurance premiums can be treated.
The above all makes sense to me, but the one thing I don't understand is the effect this has on QBI. It would seem that this reduces your QBI and therefore isn't beneficial, unless you need to raise your Box 1 for Solo 401(k) employer contributions.

What are other S Corp owners doing these days for their HSA contributions? I am located in California.
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MP123
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Re: S-Corp, HSA, and QBI

Post by MP123 »

You're right, adding HSA contributions (and Health Insurance) to W-2 box 1 reduces business income because it increases the deduction for Officer's Compensation on 1120S.

But the effect of this is complex which is why we usually suggest that people model it in tax software for their particular case. For example, if you're already over the phaseout range for an SSTB then reducing QBI won't change your Sec 199a deduction (which is zero anyway), unless, of course, it lowers it enough that you're in the top of the phaseout range now (which might be a good thing).

Also, making the HSA contribution through the S-Corp allows it to escape FICA taxes which should be figured in to the calculations. And since you're in California that adds a whole different set of considerations for State tax.

The QBI deduction is fairly new and is set to sunset in 2025 along with much of the Tax Cuts and Jobs Act.
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Re: S-Corp, HSA, and QBI

Post by plutoblackhole »

MP123 wrote: Wed Sep 28, 2022 10:57 am You're right, adding HSA contributions (and Health Insurance) to W-2 box 1 reduces business income because it increases the deduction for Officer's Compensation on 1120S.

But the effect of this is complex which is why we usually suggest that people model it in tax software for their particular case. For example, if you're already over the phaseout range for an SSTB then reducing QBI won't change your Sec 199a deduction (which is zero anyway), unless, of course, it lowers it enough that you're in the top of the phaseout range now (which might be a good thing).

Also, making the HSA contribution through the S-Corp allows it to escape FICA taxes which should be figured in to the calculations. And since you're in California that adds a whole different set of considerations for State tax.

The QBI deduction is fairly new and is set to sunset in 2025 along with much of the Tax Cuts and Jobs Act.
Hi MP123, Thanks for the response!

I'm not a SSTB, so it would definitely lower my QBI. It would avoid FICA, but in both my and my CPA's opinion, my salary is already reasonable, so I don't think there's a benefit on the Federal level.

As far as California, I considered if this could somehow let me have the HSA deduction on the state level, but I don't think that's possible, since we would deduct on 1120S, add to W2, deduct on 1040, and add it back on the California 540.

I will play around with it this year with TurboTax, hopefully it will make my understanding more clear.
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Re: S-Corp, HSA, and QBI

Post by MP123 »

plutoblackhole wrote: Wed Sep 28, 2022 11:16 am I'm not a SSTB, so it would definitely lower my QBI. It would avoid FICA, but in both my and my CPA's opinion, my salary is already reasonable, so I don't think there's a benefit on the Federal level.
Even if your compensation is already "reasonable" it would still be advantageous to make the HSA contribution through the S-Corp because then you wouldn't pay FICA on it. For example, if you make the contribution directly you would be using money that you had paid FICA on (salary from the S-Corp), even though you could deduct the contribution so it wasn't income-taxable you would still have paid FICA on it. Running it through the S-Corp lets you put it in W-2 Box 1 but not in 3 or 5, so no FICA.

Of course it may not outweigh the reduced QBI if you contribute through the S-Corp.

I don't think there's any way around having it taxable in CA though.
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Re: S-Corp, HSA, and QBI

Post by plutoblackhole »

MP123 wrote: Wed Sep 28, 2022 2:44 pm
plutoblackhole wrote: Wed Sep 28, 2022 11:16 am I'm not a SSTB, so it would definitely lower my QBI. It would avoid FICA, but in both my and my CPA's opinion, my salary is already reasonable, so I don't think there's a benefit on the Federal level.
Even if your compensation is already "reasonable" it would still be advantageous to make the HSA contribution through the S-Corp because then you wouldn't pay FICA on it. For example, if you make the contribution directly you would be using money that you had paid FICA on (salary from the S-Corp), even though you could deduct the contribution so it wasn't income-taxable you would still have paid FICA on it. Running it through the S-Corp lets you put it in W-2 Box 1 but not in 3 or 5, so no FICA.

Of course it may not outweigh the reduced QBI if you contribute through the S-Corp.

I don't think there's any way around having it taxable in CA though.
I think you just made something click in my head here. My line of thought was that if I receive $60,000 in salary, adding the HSA re-imbursement would put my box 1 at $67,300. That $7,300 was already going to avoid FICA (as a distribution), so all it would do is decrease QBI.

If I instead put my regular salary at $52,700 and add the HSA reimbursement on to my W2 at the end of the year, I'm back at the original $60,000 and avoided the FICA taxes.

Is this correct? So far I haven't found a CPA that is good at these sort of tax saving strategies, so I'm trying to figure it out on my own. Of course I still have a CPA filing the S Corp tax returns.

Thanks for your help so far by the way; it's extremely appreciated!
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Re: S-Corp, HSA, and QBI

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plutoblackhole wrote: Wed Sep 28, 2022 2:58 pm If I instead put my regular salary at $52,700 and add the HSA reimbursement on to my W2 at the end of the year, I'm back at the original $60,000 and avoided the FICA taxes.
Yes, that's correct. The same applies to health insurance premiums that are also properly included in box 1 wages (but not 3 or 5) for S-Corp owners. And both HSA and health insurance can be included as compensation for S-Corp owners when figuring solo 401k or SEP-IRA contributions too.
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Re: S-Corp, HSA, and QBI

Post by plutoblackhole »

MP123 wrote: Wed Sep 28, 2022 4:39 pm
plutoblackhole wrote: Wed Sep 28, 2022 2:58 pm If I instead put my regular salary at $52,700 and add the HSA reimbursement on to my W2 at the end of the year, I'm back at the original $60,000 and avoided the FICA taxes.
Yes, that's correct. The same applies to health insurance premiums that are also properly included in box 1 wages (but not 3 or 5) for S-Corp owners. And both HSA and health insurance can be included as compensation for S-Corp owners when figuring solo 401k or SEP-IRA contributions too.
Thank you so much for helping me finally understand this. :sharebeer

Health insurance premiums are already in Box 1 & 14 (although I don't reduce my salary by the same amount, maybe I should), but I never knew what to do with the HSA.
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Re: S-Corp, HSA, and QBI

Post by Dudweiser13 »

I would like to get some clarity on one thing not mentioned about this strategy. If you use this strategy and lower your "reasonable salary" through payroll by the amount you will be contributing to the HSA as well as the amount of your insurance premiums to reduce your FICA exposure, is that a red flag for the IRS because your "reasonable salary" is no longer "reasonable" since it is now lower. Or are the HSA contributions and insurance premiums paid by the S-Corp (or reimbursed by the S-Corp) viewed by the IRS as salary paid to the sole S-Corp owner (employee) and therefore can be calculated into the "reasonable salary" calculation?

Just want to make sure everyone has a legal leg to stand on if the IRS comes knocking and questions that "Reasonable Salary".

Thanks in advance for any responses!
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Re: S-Corp, HSA, and QBI

Post by MP123 »

Dudweiser13 wrote: Wed Jul 10, 2024 12:09 am I would like to get some clarity on one thing not mentioned about this strategy. If you use this strategy and lower your "reasonable salary" through payroll by the amount you will be contributing to the HSA as well as the amount of your insurance premiums to reduce your FICA exposure, is that a red flag for the IRS because your "reasonable salary" is no longer "reasonable" since it is now lower. Or are the HSA contributions and insurance premiums paid by the S-Corp (or reimbursed by the S-Corp) viewed by the IRS as salary paid to the sole S-Corp owner (employee) and therefore can be calculated into the "reasonable salary" calculation?
It's hard to say with certainty, because there is no statutory requirement for "reasonable compensation" or even a definition of what that might be. Instead the requirement came about through tax court cases usually involving owners taking no (or little) W2 compensation from the S-Corp and large distributions. It's very much a facts and circumstances thing.

It's clear that S-Corp HSA and health insurance need to be included in compensation in W2 Box 1. But not clear whether the IRS might, in some case, take a position that "reasonable compensation" really means "reasonable FICA-taxable compensation".
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