Mid-Year 2% Shareholder Payroll Changes

[NCA]

Checking to make sure I'm not thinking this through wrong if someone can please check me it would be greatly appreciated...

Facts: S Corporation sells some treasury stock mid-year and a new shareholder (SH) becomes a greater than 2% SH. This new 2% SH is also an employee who has been participating in a cafeteria section 125 plan for health insurance and HSA. The health insurance was partially paid by S corp employer and part by employee. Now employee SH cannot participate in cafeteria plan as a greater than 2% SH.

Question: Greater than 2% shareholder cannot participate in fringe benefits at any part of the calendar year correct? This means we have to retroactively remove the cafeteria plan medical and HSA, add the full cost of the insurance to box 1 (FICA exempt) wages, deduct after-tax for the insurance and HSA contributions. The net effect will be the employee will owe Federal and state income tax on the year-to-date insurance cost thereby reducing other wages net pay or requiring a bonus, etc. to create a net zero check.

I would love some productive feedback to make sure I've got my head around this correctly. THANKS!

[TaxGuyBill]

Offhand, I'm not familiar with anything that would retroactively affect things from BEFORE he was a >2% shareholder. Can you provide any citations to why you think that is the case?

[Anarchrist]

I wouldn't have thought that, but I have no idea what the law says about that situation. Why do you believe you have to apply the 2% rule retroactively? If an employee is made a partner on 8/1, I wouldn't have thought you'd have to change the reporting of the fringe benefits for tax purposes from 1/1 to 7/31.

[NCA]

Thanks for the responses. I guess the thought that is needs to be applied for the entire year is based on the statement in Pub 15-B with the 'at any time during the year' distinction:

Exception for S corporation shareholders.

Don't treat a 2% shareholder of an S corporation as an employee of the corporation for this purpose. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation's stock or stock with more than 2% of the voting power.

Perhaps I'm reading too much into it...

[TAXNJ]

Thanks for the responses. I guess the thought that is needs to be applied for the entire year is based on the statement in Pub 15-B with the 'at any time during the year' distinction:



Perhaps I'm reading too much into it...

See if this provides any insight?

https://www.thetaxadviser.com/issues...udy-dec11.html

and

https://www.irs.gov/pub/irs-utl/2019ntf-19.pdf

[TaxGuyBill]

Interesting, I think you are right. I think it would retroactively affect the entire year.

However, I don't see how it would require the taxpayer to have a bonus, net zero check, etc. Making past benefits taxable doesn't adjust the withholding on the current check, nor does it require the taxpayer to pay those taxes out of his paycheck. Just add it to Box 1 of the W-2. If the taxpayer was additional withholding to offset the higher box 1, the taxpayer can either change his W-4 for future checks or make an Estimated Tax Payment.

[Anarchrist]

Perhaps I'm reading too much into it...

Way too much

[Snaggletooth]

Going down the road to the end of the year, and this guy's W-2.

The amount that would have been reduced by S.125 contributions is not deducted from his Taxable Pay, as it would for other employees who are not 2% owners.
However, the amount IS reduced from his otherwise earnings subject to Social Security and Medicare.
This person is allowed to deduct his S.125 contribution as a Self-Employed person as an "Adjustment".

Someone please correct me if I'm wrong.

[NCA]

Thanks, sorry for not responding; it's been a crazy week.

Interesting, I think you are right. I think it would retroactively affect the entire year.

However, I don't see how it would require the taxpayer to have a bonus, net zero check, etc. Making past benefits taxable doesn't adjust the withholding on the current check, nor does it require the taxpayer to pay those taxes out of his paycheck. Just add it to Box 1 of the W-2. If the taxpayer was additional withholding to offset the higher box 1, the taxpayer can either change his W-4 for future checks or make an Estimated Tax Payment.

It does depend on payroll software. The software used in this company looks a YTD earnings to calculate taxes. So if we do an adjustment to move the amounts out of S125 and into a box 1 wage, the system will recalculate the entire year's Federal and state income tax YTD due minus YTD withheld. That's why I'm trying to figure out if we are going to have additional income to offset the additional taxes.

[TaxGuyBill]

That is just a software limitation, not what the rules say. Does your software allow you to override numbers?