Children/employees of S Corp owners - 125 plan participation

[Guest John Schmidt]

I understand 2% shareholders of an S corporation are not eligible to participate in a 125 plan sponsored by the corporation. I believe spouses are excluded as well because of stock attribution rules.

My client has a premium only plan for its employees' health insurance. Is the adult child of the shareholder, who is a bonafide employee, eligible to participate in the 125 plan for health insurance premiums?

[BeckyMiller]

The tax beneficial fringe benefit limits for S corporations are found in IRC Section 1372. The definition of a 2% shareholder is in part (B) which uses the attribution rules of IRC Section 318. Here ownership is attributed up and down the line - parents, grandparents, children and grandchildren of the direct shareholder.

[Guest John Schmidt]

OK, so the child can't participate in the 125 plan. If the S corporation pays the full premium outside of the cafeteria plan does it have to add the cost of the insurance to the child's W-2 as it does for the shareholder?