GTT RESOURCES: FRINGE
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Robert A. Green, CPA's below article appeared in the January 2004 issue
Trader magazine: Work in the FRINGES. Some traders have the opportunity
to take advantage of "fringe benefit" plans that can reduce
their tax liability. Find out if there's an arrangement that fits your
Here is the original article submitted, before editing by the magazine.
By Robert A. Green, CPA and CEO
If you are interested in opportunities to convert more of your non-deductible
family expenses into deductible business expenses, you should learn about
“fringe benefit" plans.
Most small businesses, including trading businesses, overlook fringe
benefit plans; many larger companies rely on fringe benefit plans to attract
and retain employees.
Fringe benefits, commonly known as “perks,” include: retirement plans;
health, life and disability insurance; education, dependent care and adoption
assistance; meals, lodging and parking; and many other types of plans.
These plans are somewhat complex and some require written “accountable
plans” with annual reporting. So, you will need the help of a competent
CPA and/or attorney specializing in “employee benefits.” It’s wise to
get a quote on costs and a projection of tax benefits to see if it’s worthwhile
for you. Our firm has this experience and we are happy to help you.
If you can convert $15,000 of family expenses into business expenses
and save taxes at 40-percent margin tax rates, you generate tax savings
of $6,000. If your professional fees and other costs are $1,500, your
return is 4-to-1. Plus, your costs are deductible business expenses, and
there are also tax credits for forming retirement plans.
The basic plans are easy for owner/traders.
Most business traders want to cover the basic employee benefits, which
include compensation, retirement plans and health-insurance coverage.
These are the easier plans to set up for owner/traders. Click
here to learn more about retirement plans.
Retirement plans are available “off the shelf” from most financial institutions
and there should be no additional expenses required.
There are also no additional expenses required in obtaining a health-insurance
plan; the only costs are the monthly premiums.
Sole proprietor (unincorporated) business traders may not set up retirement
plans or deduct health-insurance premiums (both are AGI deductions) because
trading gains are not “earned income.”
Business traders need to form a separate legal entity to pay themselves
a fee or salary on which they can then base tax-deductible retirement
and health-insurance plans.
Other fringe benefit plans are not so easy for owner/traders.
Fringe benefit plans are designed for larger companies with a large number
of rank-and-file employees.
“Discrimination” rules are intended to prevent highly compensated employees
(owner types) from monopolizing the majority of the plan benefits. If
owners and management want these benefits, they must also cover all employees.
The problem for owner/traders is that their entities of choice are “pass-through”
entities and many fringe benefit plans are not allowed for these types
Self-employed individuals (and pass-through entity owner/employees) who
want to benefit from fringe benefit plans can do so if their spouses work
for the business. By covering employees and spouses, they become entitled
to benefits by virtue of being the spouse of an employee.
The power of fringe benefit plans.
A very effective way for small businesses to maximize tax savings is
to find ways to convert fixed personal expenses into allowable business
For example, many traders covert some of their home expenses into deductible
home-office expenses. At-home traders also take business depreciation
on furniture, fixtures and equipment.
Fringe benefit plans provide additional opportunities to convert more
family expenses into business deductions.
The employee (your spouse) is reimbursed by your trading business for
his or her non-business related education, dependent care, at-home meals
and more. These types of expenses would not otherwise qualify for business
expense treatment, as they are not “ordinary and necessary” for a business.
Your company deducts the reimbursed amounts as a business expense and
your employee excludes the reimbursement from income. That means the reimbursement
is not included in their gross wages reported on a W-2 or gross compensation
on a Form 1099-Misc. In many cases, the fringe benefit is also not included
in wages calculating payroll taxes (FICA and Medicare).
For more information on all types of fringe benefits and what is excludable
for income vs. payroll tax, see IRS Pub 15-B, Employer’s Tax Guide to
Fringe Benefits at www.irs.gov.
Don’t feel bad for the IRS and think it’s just a giveaway.
Fringe benefit plans are win-win for the employer and employee; only
the IRS loses.
Don’t feel bad for the IRS because most fringe benefits plans are geared
for C-Corporations, and c-corps are subject to “double-taxation” (paying
taxes first on the corporate level up to 34 percent, and then a second
time on the shareholder level qualifying dividends and long-term
capital gains are taxed up to 15 percent).
Fringe benefits pale in comparison to the extra costs of double taxation.
You don’t need a C-Corp for fringe benefits, so choose a much better
type of entity for trading businesses.
C-Corps are a poor choice of entity for business traders. Double taxation
is costly, especially if you are highly successful. If you have trading
losses, you can not pass-through those losses to your individual tax return
for immediate tax relief.
With a “pass-through” entity, a business trader avoids double taxation
and gets immediate tax refunds on trading losses. All items of income
or loss are passing through to the individual tax level and taxes are
not paid on the entity level.
Public companies and other larger companies don’t have a choice of entities;
they can only be a C-Corp. It is simply not possible (and not allowed)
to pass items of income and expense to what could be thousands of individuals.
Smaller businesses are allowed to use pass-through entity taxation and
almost all prefer it.
Before 2003, health insurance premium deductions were limited to 70 percent
AGI deductions (lower amounts in prior years). Starting in 2003, health
insurance deductions were raised to 100 percent, putting them on par with
Starting in 2002, retirement plan contribution amounts were significantly
raised for profit-sharing plans, putting them on par with C-Corps.
Fringe benefit plan amounts are the same for C-Corps and pass through
There are no remaining advantages to a C-Corp. Business traders can use
a pass-through entity coupled with the “spouse of a non-owner employee”
strategy to unlock every conceivable tax benefit.
Choose the best pass-through entity for you early in the year.
A sole proprietorship (unincorporated business) is good for all fringe
benefit plans, except a retirement plan for the owner/employee. That is
the biggest benefit, so consider a separate entity instead.
Limited Liability Companies (LLC) are good for many traders. An LLC files
a partnership tax return, unless you elect to be taxed as a C-Corp (not
recommended per above). If you are the single member, then it’s a “disregarded
entity” (no partner, so no partnership return) and you file a Schedule
C, similar to a sole proprietorship (except you can have a retirement
Most LLCs don’t pay franchise taxes in their home state and have nominal
annual report costs (less than a few hundred dollars). You can have “special
allocations” with LLCs.
C-Corps may elect S-Corp status and then be taxed as pass-through entities.
Most states have nominal franchise taxes, which can be less than a few
hundred dollars. Allocations are based on capital accounts only.
Single traders who have other jobs and are a “close call” for trader
tax status (business status) may prefer an S-Corp over a single member
LLC; filing a separate tax return can deflect IRS questions.
here to learn more about entities for traders.
Owner/employees of “pass-through” entities are not allowed fringe
Congress structures the tax code based on give and take. Most fringe
benefit plans are given to C-Corps and then taken away for owner-employees
of pass-through entities.
All partners (in LLCs and general partnerships) and more-than-2-percent
shareholder-employees in S-Corps are not entitled to most fringe benefits
(except retirement plans).
While S-Corps can provide some of these benefits and deduct their costs,
benefits are taxable to the more-than-2-percent shareholders.
Some benefit plans (such as the Mini 401(k) plan) only apply to pass-through
There is a clever solution, as pointed out above being covered
as the spouse of a non-owner employee (your spouse).
Statutory or non-statutory plans.
Fringe benefit plans include “statutory” and “non-statutory” plans.
Statutory employee benefits (those benefits that are carved out by separate
sections of the Internal Revenue Code) include: qualified retirement plans,
group-term life insurance, medical coverage, educational assistance, certain
meals and lodging, dependent care assistance and adoption assistance.
Non-statutory fringe benefits (IRC 132) include: no-additional-cost services;
qualified employee discounts; working condition fringes; de minimis fringes;
certain transportation benefits; reimbursement of moving expenses, retirement,
financial and tax planning services; club dues; Christmas gifts and interest-free
What to do as a sole proprietor.
Sole proprietor traders who operate a trading business together with
their spouse as co-owners lose sole proprietor status and are treated
as a “defacto” husband and wife general partnership.
This is advantageous in many cases. Click
here to learn more about husband and wife general partnerships.
If your spouse is an owner, you can’t use the above solution for “being
a spouse of a non-owner employee.” You can have retirement plans
and deduct health insurance premiums.
If you structure your sole proprietorship so that your spouse is a non-owner
employee, you can use this solution for unlocking all possible fringe
benefits. The one benefit you can’t get is a retirement plan for yourself.
Retirement plan strategies.
As the only owner of your trading business with your spouse as your only
employee, you don’t have to worry about discrimination rules and can contribute
the maximum allowable amounts to both of your retirement plans.
With a 25-percent profit sharing plan and/or a Mini 401(k) plan (combines
an elective deferral [$12,000 for 2003 and $13,000 for 2004] with a 25-percent
profit sharing plan), you can control your annual tax-deductible contributions
by elective deferrals and percentages or by the amount of the fee you
declare to you and your spouse.
Defined contribution plan limits are $40,000 for 2003 (raised to $41,000
Choices of retirement plans include plans based on business income or
plans based on any type of earned income (wages included).
Business plans include profit-sharing plans, defined benefit plans, 401(k)
plans, Mini 401(k) plans, SEP plans and SIMPLE plans.
Earned income plans include traditional IRAs, Roth IRAs and education
IRAs; they are phased out at higher levels of AGI.
Some plans require an annual Form 5500 and others do not.
Highly profitable and/or older traders may want to contribute significantly
more than $40,000 per year and they can consider a “defined benefit plan.”
These plans require customization and actuaries, so the costs are higher.
here to learn more above retirement plans.
Health-insurance premiums are rising dramatically and are a significant
cost for families.
The new trend is for employers to cut back on these fringe benefits by
passing on more of the premium to the employee, often times with a “flexible
spending account” or wage withholding.
Business traders with entities can deduct health insurance premiums (by
creating earned income, see above).
These rules only apply for any calendar month in which a trader isn’t
eligible to participate in any subsidized health plan maintained by any
employer of his or her spouse.
No AGI deduction is allowed to the extent that the deduction exceeds
the trader’s fee earned from their trading business, with respect to which
the plan providing the medical care coverage was established.
These rules also apply to partners in partnerships and more-than-2-percent
shareholders of S corporations where the partnership or corporation pays
for health insurance coverage for its partners or shareholders.
If any of your health-insurance premiums are not deductible from AGI,
you can add those amounts to your itemized deductions for medical expenses
(these are deductible if they are in excess of 7.5 percent of AGI).
Medical reimbursement plans.
Families have lots of medical expenses not covered by insurance: co-pays,
dental, vision and non-covered procedures.
Consider setting up an uninsured medical plan to pay noncovered medical
costs (IRC 105(b)).
Owner/employees are not covered, so set up the plan to cover non-owner
employees and their spouses (you the owner/trader).
All medical benefits are excludable from income and payroll taxes.
Life insurance plans.
Non-owner employees can exclude the first $50,000 of group-term life
insurance coverage (IRC 79). Excess coverage is taxable to the employee
according to an IRS table; the table lists approximate market rates for
Your trading business can deduct the life-insurance premiums and your
spouse (the non-owner employee) only reports taxable income on the excess
coverage. Compare the actual premium cost to the IRS table rates (the
phantom income) to see if it’s beneficial for excess coverage in this
You can also have a “carve-out” plan a replacement individual
plan or cash in lieu of the policy.
Dependent care assistance plans.
Many traders with families spend money on dependent care assistance and
can benefit from this type of fringe benefit plan.
Employees can exclude up to $5,000 of employer-paid dependent care costs
(not to exceed earned income; this is covered in IRC 129). The plan must
These excluded amounts can not be part of a child care tax credit. You
should consult with your accountant to see which is preferable for your
If you opt for a child care credit instead, note both spouses need earned
income. Using a pass-through entity, a trader can pay a fee (earned income)
to both spouses.
Are flexible spending accounts (FSA) good for traders?
Big companies use “flexible spending accounts” (FSAs) with “salary reduction”
to shift the cost of fringe benefit plans onto employees.
It’s good for employees because it lowers their taxable salary amount;
the excluded amounts are pre-tax. With some FSA plans, the excluded benefits
are also exempt from payroll taxes (such as is the case with dependent
care assistance FSA plans).
Be careful of the “use it or lose it” features in FSAs. If you don’t
use the FSA amount deposited or withheld, you may lose it for good.
Business traders don’t need FSAs as they are not concerned with shifting
the burden to other family members.
Educational assistance plans and education deductions.
Employees can exclude up to $5,250 of employer-paid educational assistance
It applies to just about any kind of course or program including graduate
level courses, even if it isn't job or business related.
Excess amounts can still qualify for the exclusion under the working
condition fringe benefit rules. For example, if you take computer training
for $10,000 it can all be excluded (because it's job related).
Excludable amounts are not subject to payroll taxes.
Traders face challenges in deducting education expenses as normal business
expenses. Business related educational expenses paid after a trading business
is commenced are deductible business expenses. However, education expenses
paid before business commencement may be non-deductible.
For a tax deduction, your education expenses must help you maintain or
improve your employment or business skills, or be required for you to
keep your job (or your business), your salary level or your current status.
The education cannot, however, enable you to meet the minimum qualifications
for your job, or qualify you for a new trade or business.
A stock broker is already in the trading field, so pre-trading business
education can be deductible. An attorney studying the trading business
before starting to trade may be denied the deduction. Protect your deduction
by paying education bills after you commence actual trading.
There are also many types of educational credits available for all family
Employees can exclude adoption assistance up to $10,000 if their AGI
is below set limits (IRC 137). The exclusion applies to income and payroll
Meals and lodging plans.
These expenses can be fully excluded providing you meet the following
The meals must be provided on the employer’s premises. Many traders don’t
go out to lunch; they are glued to their screens throughout the day, just
like other traders working for large firms.
Lodging must be furnished on the employer’s premises and the employee
must accept it as a condition of employment. This lodging exclusion is
too aggressive to consider for at-home traders. The home office rules
are intended to cover these expenses
Shift income to children.
If your children are of working age and truly capable of helping you in
your trading business, consider paying them wages or fees and including
them in your employee and fringe benefit plans.
This also shifts some of your income from higher marginal tax rates to
a child’s lower marginal tax rates. Consider Roth IRAs for your working
children. You can trade their Roth IRA and all the income builds tax-free
on a permanent basis; whereas traditional IRAs are tax-deferred only (i.e.,
they are taxed upon withdrawal).
Fringe benefit plans are somewhat complex and cost some money to implement,
but they can be well worth the effort and cost. Consult with a trader
tax expert who also is experienced in benefits law. They can determine
whether any or all of these plans are right for you and your family.
If you have any questions on fringe benefit
plans, consider a consultation with a GTT CPA. Feel free to post questions
on our message
board and/or e-mail us at email@example.com
or call us.
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