change from employee to s-corp owner

[Guest bbean]

if an employee becomes a greater than 2% owner of an S-corp during the year, are we required to terminate the section 125 plan deductions/participation at the point the employee becomes an owner of the s-corp, or is eligibility for the employee determined at the start of the year and extend until the next year begins?

[Guest sniffles]

if an employee becomes a greater than 2% owner of an S-corp during the year, are we required to terminate the section 125 plan deductions/participation at the point the employee becomes an owner of the s-corp, or is eligibility for the employee determined at the start of the year and extend until the next year begins?

We filed Form 8869 Qualified Subchapter "S" Election with the IRS. On that Form there is a place for "Date election is to take effect." Ours took effect for Plan Year 2006. We received the notice from the IRS in May 2006 that our S-Corp status was approved so at the end of the year I had to reverse the 2% owner's health deductions (for the whole year) so that he paid taxes on them through one of his last paychecks for the year. Then I had to send him a separate W-2 for the Employer-paid portion on the health insurance.........so I believe if they become a 2% owner at any time during the year then their health insurance becomes taxable. The 2% owner still pays his portion of the health insurance, it is now taxable so it's not deducted from his paycheck under the Section 125.

Hope this helps!

[Guest morris]

I think it would be determined based on how the employee (new S-corp owner) filed his personal tax return for the whole year--probably as self employed. In which case, you've got to go thru the gauntlet indicated by sniffles.

To directly answer your question, the employee must come out of the 125 plan at the moment he becomes a greater than 2% shareholder, or the plan is null and void.