Can 2% Shareholders Participate in FSA/HSA Plans, and How Should Their Benefits Be Handled in Payroll?

No, 2% shareholders of an S Corporation (or an LLC taxed as an S Corp) are not eligible for tax-advantaged benefits such as Flexible Spending Accounts (FSA) or Health Savings Accounts (HSA), as per IRS rules. These benefits are reserved for regular employees only. Assigning such plans to a 2% shareholder can lead to compliance violations, and any contributions made must be treated as fully taxable income.

If an employee is identified as a 2% shareholder mid-year, the IRS requires the status to be applied retroactively from January 1 of that calendar year. This means:

• Any pre-tax benefits (like Medical, HSA, FSA) already processed must be reversed.

• Payroll records for previous quarters may need to be amended.

• If W-2 forms were already issued, corrected versions (W-2c) may be required.

Keka does not withhold taxes on such benefit-related earnings. Instead, these are reported as taxable income on the employee's W-2, and the individual is responsible for paying the necessary taxes when filing their personal tax return.