Change an employee's 2% shareholder status - S-corps

Summary

Admins can learn how to identify employees who are 2 percent S-Corp shareholders in Gusto—based on when the update is made, and if they've already had benefit deductions, next steps will vary.

Users Intent

Context Variations

Content

To identify the employees who are 2% S-Corp shareholders in Gusto, your business must be listed as:

A C Corporation (C-Corp) that's taxed as an S-Corp or;
An LLC (that's taxed as an S-Corp).

If your company is not set up in Gusto as a C-Corp or LLC that's taxed as an S-Corp, change your entity type first.

If you're changing an employee's shareholder (owner) classification in Gusto, the timing of the change and if they've had previous benefit deductions determine next steps. Choose the most applicable scenario from the dropdowns below to learn more.

Important reminders

Make sure an employee-owner's 2% shareholder status is accurate—this affects how their health insurance premiums are taxed and affects eligibility for other benefits.
- 2% or less shareholders who are paid as W-2 employees are eligible to participate in pre-tax section 125 benefit deductions.
- Greater than 2% shareholders are not eligible to participate in pre-tax section 125 benefit deductions (IRS resource here).
  - If benefits are being deducted as pre-tax, they should be corrected.
- If you have Gusto-managed benefits, we need to know if your shareholders are 2% or less, or greater than 2% shareholders, so we can make sure your contribution scheme is compliant.
Gusto does not support 2% shareholder owners who need to receive both a taxable salary and a non-taxed distribution —if you have an owner who is a W-2 employee (with taxable wages) but requires tax-free distributions, you'll have to handle the distributions for this person outside of Gusto (and any related tax forms).

Beginning of the year update to shareholder status—no previous deductions or contributions

If you’re updating an employee’s shareholder status to 2%, and it’s the beginning of the calendar year, follow these steps:

Go to the People section.
Click on your employee's name.
In the Job tab, find the "Work" section.
Next to “Work” click Edit.
Choose Yes in the “2% Shareholder” dropdown—this means the shareholder is a greater than 2% owner of the company.
- If you do not see the option to set someone up as a 2% shareholder: Message us from the section of your account.
- To change the designation to “No” after it's already been set to "Yes," you'll need to message us from the section of your account so we can work through tax implications with you.
Click Save.

Mid-year or end of year update to shareholder status—no previous deductions or contributions

If you’re updating an employee’s 2% shareholder status mid-or-end of the year, and they have NOT received pre-tax benefit deductions so far (e.g., your company has not been withholding health insurance premiums), learn how to fix the benefit totals below:

Go to the People section.
Click on your employee's name.
In the Job tab, find the "Work" section.
Next to “Work” click Edit.
Choose Yes in “2% Shareholder” dropdown—this means the shareholder is a greater than 2% owner of the company.
- If you do not see the option to set someone up as a 2% shareholder: Message us from the section of your account.
- To change the designation to “No” after it's already been set to “Yes,” you'll need to message us from the section of your account so we can work through tax implications with you.
Process a benefits correction for the shareholder—when creating the benefit for your 2% shareholder, you’ll need to put in the year-to-date amount that should be reported on your W-2s for this year. Add the total year-to-date amount as the “Company Contribution Per Pay Period”.
Once the correction is processed, either disable the benefit entirely by removing it, or adjust the amounts to reflect the per-payroll contribution amount that you’d like to apply to future payrolls—this will make sure the deductions and contributions are being recorded for your employees' W-2s moving forward.

Pre-tax benefit deductions need correcting—the shareholder was misclassified

If you’re updating an employee’s 2% shareholder status mid-or-end of the year, and they HAVE received pre-tax benefit deductions this calendar year (e.g., your company withheld health insurance premiums)—our team will need to help with adjusting their benefits as there are tax implications.

Message us from the section of your account, and include:

The names of the employees who are 2% shareholders
The year-to-date benefit totals medical, dental, or vision

Our team will get in touch with next steps.

Shareholder designations for C-Corporation payroll

C-Corporation employees who are also shareholders do not need a special designation in payroll. They are treated the same as all other employees for wages, benefits, and payroll taxes.

Do I need to mark employees as shareholders in Gusto?

No. For C-Corporations, shareholder-employees are treated just like regular employees. They receive the same payroll tax treatment.

They are eligible for all standard pre-tax benefits without restrictions.

How is this different for S-Corporations?

S-Corp shareholders with more than 2% ownership must be designated. These shareholders are treated as partners for fringe benefit purposes.

Most pre-tax benefits become taxable income for them.

What this means for your payroll

Set up C-Corp shareholder-employees as regular employees in Gusto. They automatically qualify for full pre-tax benefit eligibility.

No special payroll rules or restrictions apply.

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