Many small business owners operate as S corporations and want to take advantage of the same tax-advantaged benefits available to their employees. One common question is whether an S corporation owner can participate in a Section 125 Cafeteria Plan.
The answer is generally no for shareholders who own more than 2% of the S corporation.
Although an S corporation can establish and sponsor a cafeteria plan for its employees, the tax rules treat certain owners differently than regular employees.
Understanding these rules can help employers avoid compliance issues and ensure their benefit plans are administered correctly.
What Is a Cafeteria Plan?
A Section 125 Cafeteria Plan allows employees to pay for certain qualified benefits with pre-tax payroll deductions.
Common benefits offered through a cafeteria plan include:
- Healthcare Flexible Spending Accounts (FSAs)
- Dependent Care Flexible Spending Accounts
- Employee health insurance premiums
- Dental insurance premiums
- Vision insurance premiums
- Certain other qualified benefits permitted under IRS rules
By participating in a cafeteria plan, eligible employees may reduce their taxable income while receiving valuable employee benefits.
Can an S Corporation Owner Participate?
In most cases, shareholders who own more than 2% of an S corporation are not eligible to participate in a Section 125 Cafeteria Plan on a tax-free basis.
For federal tax purposes, these individuals are treated differently than common-law employees.
As a result, they generally cannot receive the tax advantages that rank-and-file employees receive through a cafeteria plan.
Can the S Corporation Still Offer a Cafeteria Plan?
Yes.
An S corporation may absolutely establish a cafeteria plan for its eligible employees.
The ownership restrictions apply to more-than-2% shareholders—not to the company itself.
Many S corporations successfully offer benefits such as:
- Healthcare FSAs
- Dependent Care FSAs
- Premium Only Plans (POPs)
- Other Section 125 benefits for eligible employees
The business owner simply follows different tax rules than the employees.
Can an S Corporation Owner Participate in an FSA?
Generally, no.
A more-than-2% shareholder typically cannot participate in a Healthcare Flexible Spending Account on the same tax-advantaged basis as other employees because the FSA is offered through the Section 125 Cafeteria Plan.
However, eligible non-owner employees may still participate in the employer’s FSA.
What About a Dependent Care FSA?
The same general rule applies.
More-than-2% S corporation shareholders are generally not eligible to receive the tax-free benefits of a Dependent Care Flexible Spending Account through a cafeteria plan.
Employees who are not subject to the ownership restrictions may still participate if they are otherwise eligible.
What About a Health Savings Account (HSA)?
Health Savings Accounts (HSAs) are treated differently than Flexible Spending Accounts.
If an S corporation owner is enrolled in a qualified High Deductible Health Plan (HDHP) and otherwise meets the IRS eligibility requirements, the owner may generally contribute to an HSA.
Employer contributions made on behalf of a more-than-2% shareholder are generally included in the shareholder’s taxable wages. However, those contributions may still be deductible by the shareholder as an “above-the-line” deduction on the individual’s federal income tax return, provided all HSA eligibility requirements are met.
Many S corporation owners choose to:
- Have the corporation make HSA contributions during the year.
- Include those contributions in the shareholder’s Form W-2 wages.
- Claim the HSA deduction when filing their individual income tax return.
This treatment is different from a Healthcare Flexible Spending Account, which generally is not available to more-than-2% S corporation shareholders through a Section 125 Cafeteria Plan.
Because HSA eligibility and tax reporting depend on several factors, business owners should work with their tax advisor to ensure contributions are reported correctly.
Can an S Corporation Owner Pay Health Insurance Premiums Through Payroll?
S corporation owners are subject to special tax rules regarding health insurance premiums.
In many cases:
- The corporation pays or reimburses the premiums.
- The premiums are included in the shareholder’s taxable wages.
- The shareholder may then be eligible to claim the self-employed health insurance deduction if applicable.
Because these rules involve both payroll and income tax reporting, employers should work with their accountant or tax advisor to ensure the premiums are handled correctly.
Why Are S Corporation Owners Treated Differently?
Congress created special tax rules for certain business owners to prevent individuals with significant ownership interests from receiving the same tax treatment available to rank-and-file employees through Section 125 plans.
While this creates additional complexity, it does not prevent an S corporation from offering valuable employee benefits to its workforce.
Common Questions
Can my spouse participate?
Possibly not.
IRS ownership attribution rules may treat certain family members as owning the shareholder’s stock.
Because these rules can affect eligibility, employers should consult qualified tax advisors regarding their specific ownership structure.
Can I simply deduct my FSA contributions another way?
Generally, no.
Healthcare FSAs receive their tax advantages through a Section 125 Cafeteria Plan, and more-than-2% shareholders are generally not eligible for that treatment.
How Empower Helps S Corporations
Many small businesses are organized as S corporations, and understanding employee benefit rules for owners can be confusing.
Empower helps employers establish and administer compliant cafeteria plans while providing guidance on participant eligibility and plan administration.
Although business owners should always work with their tax professionals regarding individual tax treatment, we help employers understand how cafeteria plans, Flexible Spending Accounts, and other benefit programs are administered under applicable rules.
Questions About Cafeteria Plans?
Whether you are establishing your first cafeteria plan or reviewing your current employee benefits, Empower can help you understand your options.
Contact us to learn more about Section 125 Cafeteria Plans, Flexible Spending Accounts, and employee benefit administration for small businesses.
