Update 2% shareholder status for S-Corp employees in Gusto
This article is for employers with S-Corp tax status who need to update an employee’s 2% shareholder status in Gusto.
To mark employees as 2% S-Corp shareholders in Gusto, you need to set up your business entity type as:
A C Corporation (C-Corp) taxed as an S-Corp
An LLC taxed as an S-Corp
If your company is not set up as a C-Corp or LLC taxed as an S-Corp, change your entity type first.
What you need to know about 2% shareholder status
Make sure you mark an employee-owner’s 2% shareholder status correctly. This status affects how we tax their health insurance premiums and their eligibility for other benefits.
Shareholders who own 2% or less and get W-2 wages can participate in pre-tax Section 125 benefit deductions.
Shareholders who own more than 2% cannot participate in pre-tax Section 125 benefit deductions (see this IRS resource on shareholder compensation).
If you deduct benefits as pre-tax for a shareholder who owns more than 2%, you need to correct this.
If Gusto manages your benefits, tell us whether your shareholders own 2% or less, or more than 2%. This helps us make sure your contribution setup meets compliance requirements.
If you manage your own medical, dental, vision, or HSA benefit in Gusto, we apply the appropriate taxes to their employee deductions and contributions.
We do not support 2% shareholder owners who need both a taxable salary and a non-taxed owner’s draw. If you have an owner who gets W-2 wages but also needs owner’s draws, handle the owner’s draws outside of Gusto, along with any related tax forms.
When you change an employee’s shareholder (owner) classification in Gusto, the timing matters. Whether they had previous benefit deductions also affects your next steps. Choose the scenario below that best fits your situation.
Employees who are 2% or greater shareholders at any point during the calendar year must be taxed as such for the entire year.
To update an employee's shareholder status to 2% at the beginning of the calendar year, follow these steps.
Go to People.
Click your employee's name.
Under Information, click Work.
Find the Work section and click Edit.
Choose Yes in the 2% Shareholder dropdown. This marks the shareholder as owning more than 2% of the company.
Contact us if you cannot find the option to set someone up as a 2% shareholder.
To change this selection after you've already saved it, contact us so we can work through the tax effects with you.
To contact us, sign in to your Gusto account and click the help icon
in the top-right corner of the page.
Click Save.
To update an employee’s 2% shareholder status mid-year or at the end of the year—when they have not gotten pre-tax benefit deductions this year (for example, your company did not withhold health insurance premiums)—follow these steps.
Go to People.
Click your employee’s name.
Under Information, click Work.
Find the Work section and click Edit.
Choose Yes in the 2% Shareholder dropdown. This marks the shareholder as owning more than 2% of the company.
Contact us if you cannot find the option to set someone up as a 2% shareholder.
To change this selection after you’ve already saved it, contact us so we can work through the tax effects with you.
To contact us, sign in to your Gusto account and click the help icon
in the top-right corner of the page.
Process a benefits correction for the shareholder. When you create the benefit for your 2% shareholder, enter the year-to-date amount that we should report on the shareholder’s W-2 for this year. Add the total year-to-date amount as the Company Contribution Per Pay Period.
Once we process the correction, remove the benefit or adjust the amounts to reflect the per-payroll contribution you want going forward. This makes sure we accurately record the deductions and contributions on your employees’ W-2s.
If you update an employee’s 2% shareholder status mid-year or at the end of the year, and they have gotten pre-tax benefit deductions this calendar year (for example, your company withheld health insurance premiums), you’ll need to contact us. Our team can help you adjust their benefits, since this has tax implications. To contact us, sign in to your Gusto account and click the help icon in the top-right corner of the page.
Include:
The names of the employees who are 2% shareholders
The year-to-date benefit totals for medical, dental, or vision
Our team will contact you with the next steps.
C-Corporation employees who also own shares do not need a special status in payroll. We treat them the same as all other employees in terms of wages, benefits, and payroll taxes.
Set up C-Corp shareholder-employees as regular employees in Gusto. They automatically qualify for full pre-tax benefit eligibility. No special payroll rules or restrictions apply.
Q: Do I need to mark employees as shareholders in Gusto for C-Corporations?
A: No. For C-Corporations, we treat shareholder-employees just like regular employees. They get the same payroll tax treatment and can access all standard pre-tax benefits without restrictions.
Q: How does S-Corporation shareholder status differ from C-Corporation?
A: For an S-Corp, you need to mark shareholders who own more than 2%. The IRS treats these shareholders as partners for fringe benefit purposes, which means most pre-tax benefits become taxable income for them.