Type of business entity as factor in establishing PS Plan?

[billfgrady]

Client is the sole shareholder (and sole employee) of an S corporation. S corporation is going to set up a Cafeteria Plan and a profit sharing plan. Client's accountant suggested that the entity covert from S to C status before doing so to gain tax advantages. From the side of Section 125, I can see the advantage since a more than 2% shareholder of an S corporation would not be permitted to participate in a Cafeteria Plan. But from the side of a profit sharing plan, what advantages would there be to convert from S to C status?

[Belgarath]

Only speculating here. You can only use the W-2 income from the S-corp - you cannot use the "pass-through" income for the profit sharing plan. Now, I don't know anything about the mechanics of how the income is determined to be W-2 or pass-through. But if a large share of the income is pass-through and cannot be reclassified to W-2, but could be counted as "earned income" for the sole prop, then that might be a reason.

[Guest nherkowitz]

Also look out because IRC Section 125(b)(2) states that no more than 25% of the benefits of the plan can go to key employees. Your sole owner/employee will cause this cafeteria plan test to fail.

[JAY21]

I don't see any pros or cons from the profit sharing plan's perspective since only w-2 comp could be used either under an S-Corp or a C-Corp.

I do agree with nherkowitz comments on the 125 plan. I don't see how the 125 plan can be done given the key employee rule. The 125 plans are problematic for owners of small companies if the intent is for the owners to significantly benefit. It takes significant staff participation and thus a larger employee base to "free up" enough room under discrimination testing and the 25% concentration test (key employee test) to allow for any significant benefits to the owner(s).

[Belgarath]

Sorry, I just realized that I read this incorrectly the first time - I was thinking they were possibly converting to a sole proprietorship, where what you said was a C-corp. So my response made no sense whatsoever!