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 must set up your business entity type as:
A C Corporation (C-Corp) that’s taxed as an S-Corp or
An LLC that’s taxed as an S-Corp
If your company is not set up as a C-Corp or LLC that’s 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 affects their eligibility for other benefits.
Shareholders who own 2% or less and receive 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 (IRS resource here).
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.
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 receives W-2 wages but requires 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.
To update an employee’s shareholder status to 2% at the beginning of the calendar year:
Go to People.
Click on 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% owner of the company.
Contact us if you cannot find the option to set someone up as a 2% shareholder.
To change the selection from No to Yes after you already set it to Yes, 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 received pre-tax benefit deductions this year (Example: Your company did not withhold health insurance premiums):
Go to People.
Click on 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% company.
Contact us if you cannot find the option to set someone up as a 2% shareholder.
To change the selection from No to Yes after you set it to Yes, 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 Gusto 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, either remove the benefit or adjust the amounts to show the per-payroll contribution amount you want to apply to future payrolls. This makes sure that we accurately record the deductions and contributions on your employees’ W-2s going forward.
If you update an employee’s 2% shareholder status mid-year or at the end of the year, and they HAVE received pre-tax benefit deductions this calendar year (Example: Your company withheld health insurance premiums), you'll need to contact us. Our team can help you adjust their benefits, as 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.
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 receive 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 must 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.
What this means for your C-Corp payroll
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.