Discussed on this page are some of the more popular benefits available to owners and/or employees of trading entities.
A brief overview of lesser-known benefits is provided first and then some detail about the more popular ones afterwards.
This is by no means an exhaustive treatment. An employment benefits specialist may need to be consulted.
Each of the following plans is required to be written and typically subject to discrimination testing and adequate notification.
Educational Assistance Program - amounts paid by an employer for educational assistance are excluded from gross income and also employment tax (FICA/FUTA). Benefits may not exceed $5,250 annually to any one employee. Form 5500 must be filed annually. Unfortunately, this benefit is generally not available to a 5% or greater owner or shareholder in a trading entity.
Employer reimbursement for education costs - amounts paid to employees to reimburse them for job-related educational costs are excluded from income if:
The employee is required and does provide documentation,
Expenses are equal to or greater than reimbursement, and
Employee does not claim a deduction on individual income tax return for the same expense.
Only deductible if maintains or improves skills in current employment.
Dependent Care Assistance - provides assistance for employees in meeting their child and dependent care obligations. The benefit is up to $5,000 per year and affects the employees ability to fully utilize the Dependent Care Tax Credit. Qualifying dependents are children under age 13 and others if physically or mentally incapable of caring for themselves.
Adoption Assistance Programs - qualified adoption expenses paid by an employer are excluded from an employee’s gross income but are subject to employment tax (FICA/FUTA).
There are many other employee benefits, such as, no additional cost services, on-site athletic facilities, employer-provided transportation, qualified retirement planning services and others. However, they have little, if any, applicability to a home-office based, owner-run trading entity.
If one is interested in the above benefits, it would be well worth consulting an employee benefit specialist.
Having one’s employer provide an automobile represents a substantial employee benefit. However, as are many benefits, when the employee is also the employer or owner, there are significant hurdles to clear.
Generally, an employer may provide a vehicle to its employees for use in the employer’s trade or business. However, if the employee uses the vehicle for personal use, that use is includible in the employee’s gross income. Further, there are substantiation requirements regarding the use of a company-owned vehicle. The employer, however, reflects the business-use of the vehicle as 100% on the company’s Form 4562.
There are multiple methods for valuing the personal use of a company-owned vehicle, but most are not applicable if the user of the vehicle is also an owner. Ownership percentage for this purpose is 1%, meaning that if you or your spouse own more than 1% of the entity - stock, profits, capital - you fall under a different set of rules.
The valuation of a company-owned vehicle for a 1% or greater owner (and there are other criteria besides ownership, such as compensation) uses the Annual Lease Value Table (ALV) which is based on the fair market value (FMV) of the vehicle.
The inclusion calculation is somewhat complicated but basically allocates the lease value between personal and business use based on the percentage of personal miles to total miles driven for the year. If the company also pays for fuel, 5.5¢ per personal-use mile is added to the lease value. That total is subject to employment tax and is included in the employee’s W-2. Federal income tax withholding is not required but will be paid when the employee files his Form 1040.
An alternative to lease value inclusion is available to owners, except sole proprietors, in the form of accountable plan reimbursement. The owner is reimbursed by the company at a federally determined rate based on the number of miles driven for deductible business purposes. Again, the employee must substantiate the amount, time, use and business purpose. The rate changes annually. To see the current and prior year rates, click here.
Let’s look at an example:
Mary has a trading business that she operates throughout the year and meets the criteria to be a trader. She runs the business from her home office which is used regularly and exclusively for her trading business, thus, it is her principal place of business.
She purchases a luxury auto with several amenities. The total cost is $52,000. She drives the vehicle a total of 15,000 miles this year. Her business miles are only 3,000 miles consisting of driving to the office supply store, airport to travel to conferences, meeting with her trading group and several other business-related trips.
The ALV for her vehicle is $13,750 and her personal mileage represents 80% of her total use [ (15,000 total - 3,000 business) / 15,000 total ]. Her trading business also pays for all her fuel. Her employment tax liability is $1,783.98 and $11,660 will be included in Box 1 of her W-2.
Mary will be able to take the full amount of depreciation for the vehicle, subject to the IRC Sec 280F limitations for luxury* autos.
Click on the auto icon below to see the value inclusion calculations.
* luxury is defined by IRS based on FMV of vehicle when placed into service
Health & Medical Plans
Health and medical insurance is generally deductible by employers and not includible in the gross income of employees.
Given the meteoric increase in health insurance premiums, it is desirable for the trading entity to provide health benefits for its owner-employee. This is where entity selection has a significant impact on how health insurance premiums are deducted.
The following characteristics pertain to insured plans, those where insurance premiums are paid to an insurance company for coverage and not self-insured plans which are subject to discrimination requirements.
C Corporation - premiums are deductible by the corporation
S Corporation - premiums are includible in the gross income of a greater than 2% shareholder and deductible by the corporation as compensation. Health insurance premiums paid by the corporation are not subject to employment tax. For example, an S Corporation shareholder pays himself $60,000 in wages during the year and the corporation pays $12,000 in health insurance benefits. Here is how the W-2 would appear.
Partnerships - health insurance premiums are deductible as guaranteed payments to the partners includible in their income and deductible by the partnership. The premiums are considered self-employed health insurance premiums and are not subject to self-employment tax.
Sole proprietor - Under Section 105 of the Internal Revenue Code, a sole proprietor may setup a Health Reimbursement Account (HRA) for employees. If the employee’s spouse is the insured then the health insurance premiums become deductible for both income tax and self-employment tax purposes. However, all employees must be covered.
Limited Liability Company - based on how the entity is taxed for federal tax purposes. Thus, if the owner is a single-member LLC (SMLLC) and files a Form 1040 Schedule C, the sole proprietor rules are followed, as would be the case if the LLC were taxed as a partnership (default), C Corporation or S Corporation.
Section 125 Plans
Commonly referred to as “cafeteria” plans because they offer a menu of benefits and cash from which an employee may choose. The selected benefit is not included in the employee’s gross income, unless the employee chooses cash, which is a required offering by the plan.
The plan must be written and there are a number of common benefits that may be included along with a list of those that may not. It is essential to engage a benefit specialist if you desire to offer cafeteria-style benefits.
Here is list of common cafeteria plan benefits:
Group-term life insurance up to $50,000
Medical and health plan insurance under IRC Sec 105 or 106
Long- or short-term disability
Dependent care assistance
Health Savings Accounts
Flexible Spending Accounts
This is potentially the “mother” of all employee benefits.
Retirement plans come in many shapes and sizes, from defined benefit plans which provide an actuarially-determined benefit to the retiree to Individual Retirement Accounts.
All plans must be written and most must provide minimum vesting, nondiscrimination and participation requirements.
Here are some of the more popular ones:
Pension plans - broken into two types: defined benefit and defined contribution plans. These plans must provide definitely determinable benefits for retirement during the life of the employee.
Profit-sharing plans - allow employees to share in the profits of the company. There are a number of requirements including the provision of an allocation formula and distribution of funds upon the occurrence of certain events, such as, reaching a certain age or separation from service.
401(k) plans - also termed cash or deferred arrangements. These plans must meet the written plan and non-discrimination requirements of other qualified plans. The employee elects to have the employer defer compensation or pay the employee an equivalent amount of cash or other taxable benefit.
SIMPLE - which stands for Savings Investment Match Plans for Employees of Small Employers. There are a number of requirements for establishing a SIMPLE, such as the number of employees, whether other plans are currently in operation and the amount of employer matching. Under a SIMPLE, employees elect to defer a certain amount of salary, limited to amounts announced annually by IRS and the employer matches a certain percentage of compensation up to 3%.
Simplified Employee Pension - otherwise termed an SEP provides for a percentage of compensation formula for all employees, not to exceed 25%. The employee makes no contribution. The written plan is provided using an IRS form (Form 5305-SEP) and each employee’s account is immediately vested. This plan is like a “super”-IRA for each employee.
Individual Retirement Accounts - may be utilized by individuals and employees of trading entities and/or sole proprietors that meet certain income requirements. IRAs are the easiest to setup but also provide the least amount of benefit.
Trading the Retirement Plan
It is possible to trade your retirement plan depending upon which plan is adopted. A retirement plan may not use margin but can trade options in similar fashion to regular marginable accounts.
The account title must match the plan name. For instance, an entity named ABC Trading LLC has adopted a profit-sharing plan. The retirement plan should have the name of ABC Trading LLC Profit-Sharing Plan at the brokerage. No separate taxpayer identification number is required.
Also, because of requirements stipulated in the Patriot Act, any funding should come from a checking account with the same title. For instance, a checking account, most likely at the bank where the trading entity has its account, may need to be setup with the same title as the retirement account at the brokerage, in this case, the ABC Trading LLC Profit-Sharing Plan.
This may or may not be required, depending on your brokerage, just be aware of this possible administrative requirement.
Office in Home
The deduction for having an office in your home is not as beneficial for trading entities as it is for other trades or businesses.
For non-trading entities, office in home deductions can significantly decrease self-employment tax but for trading entities there is no self-employment tax and the income is reported either on Schedule D or Form 4797 (and sometimes Form 6781) depending on whether one has made a mark-to-market election.
Even though it is of less benefit, it is still a benefit that can be claimed if you qualify. So how does one qualify?
First of all, there must be a trade or business involved, which means your trading has to rise to the level of that of a trader as opposed to an investor. If you do not qualify as a trader, then your investment deductions are reported as Miscellaneous Itemized Deductions on Schedule A and subject to a 2% of Adjusted Gross Income threshold.
If you do qualify as a trader, then you will deduct your trading expenses on Schedule C and potentially your home office deductions on Form 8829.
Secondly, if you qualify as a trader and have what you believe to be a home office, you must exceed these thresholds for that office to qualify as a home office:
There must be a specific room set aside for your trading and it must be used regularly and exclusively for trading:
Regularly - if you meet the requirements to be a trader you will meet this requirement; basically frequent, regular use as an office
Exclusively - trading is all you do in this room - it is not a storage or exercise room nor is it equipped with a big screen television in order to watch sports events with friends nor a bed for relatives
It can be a separate structure not attached to your house but still must meet the above criteria
The benefits of the home office, in the case of a trader, would be the additional deduction for the pro-rata share of utilities, insurance, repairs and depreciation for that portion of the home office, determined by the square footage of the home office as it relates to the square footage of the entire home. This is calculated at the top of Form 8829.
The deduction for mortgage interest and property tax are deductible on Schedule A (if not using home office) or Form 8829 (if claiming a home office). If you do not qualify for Schedule A because you take the Standard Deduction, you may not deduct these on Form 8829 in addition to the Standard Deduction. However, it seems that if you could itemize, except for the allocation of mortgage interest and property tax to Form 8829, then you may be able to take the Standard Deduction and deduct mortgage interest and property tax in addition.
Employee Office In Home
If you are trading inside a separate entity where you are an employee of that entity, then your home office deductibility is modified.
First, you may only deduct home office expenses if it is for the convenience of your employer, and since an entity in which you control is the employer, you will presumably meet this requirement.
Secondly, the expenses are only deductible on Form 2106 Employee Business Expenses which are Miscellaneous Itemized Deductions subject to the 2% of Adjusted Gross Income threshold. Therefore, you may not meet the threshold.
Thus, from this perspective, one would opt to be a single-member LLC and file a Schedule C as a disregarded entity along with Form 8829.