S Corporation Year End Payroll Reporting Considerations

S Corporation Year End Payroll Reporting Considerations - Fringe Benefits

September 17, 2025

by Lauren Foley, MSA

As 12/31 approaches, an important consideration for employers is proper payroll reporting. W-2s must be sent to employees by 1/31, resulting in a very short window in which to ensure that final payroll is correct for tax reporting. In addition to compensation, employers must be sure that benefits are properly reported, including “fringe benefits.”

Fringe benefits are considered compensation and included in employee wages, UNLESS they qualify for exclusion (i.e., are nontaxable and omitted from employee wages). However, if the recipient is a “2% shareholder” (i.e., an owner AND employee) of an S Corporation, fringe benefits that otherwise qualify for exclusion are included in wages. The general rules are illustrated as show in graphic below.

What are Fringe Benefits?

A fringe benefit is a form of pay, including cash, amounts paid on behalf of an employee (e.g., health and life insurance, retirement and health accounts), or in-kind (e.g., property, meals, company cars), in addition to stated pay for the performance of services. Under the Internal Revenue Code (“Code”), The Code provides that fringe benefits are taxable, excluded or partially taxable, depending on the type of benefit. If a fringe benefit is excluded or partially taxable, it must be “qualified”, i.e., meet strict requirements to qualify for this preferential tax treatment. Even if excluded or partially taxable by employees, employers may deduct the cost of fringe benefits.

What are S Corporations?

Qualifying corporations that make “S” elections under the Code are not separately taxed, as regular (“C”) corporations are. S Corp status allows corporations to avoid double taxation by passing income, losses and deductions to its shareholders, who report these items directly on their tax returns. Often, S Corp shareholders are also employees.

Fringe Benefits & S Corp 2% Shareholder-Employees

Due to the overlap between owner and employee status, special rules apply to S Corp shareholder-employee fringe benefit taxation and reporting. These rules apply to shareholders owning 2% or more of S Corp stock (“2% shareholders”). Even if excludible by regular employees, 2% shareholder benefits are generally taxable and must be reported on the shareholder’s W-2. The following benefits are treated differently for 2% shareholders:

Health insurance premiums are taxable and included on 2% shareholder-employee W-2s. Regular employees W-2 wage does not include the employer paid portion of their health insurance.

Retirement plan contributions are subject to self-employed contribution rules for 2% shareholder-employees. These rules allow contribution of 25% of net earnings from self-employment. Retirement plan contributions for regular employees are nontaxable if they are within limits.
Dependent care assistance from an employer is tax free up to $5,000 for regular employees, while all dependent care benefits are taxable to 2% shareholder-employees.
Group term life insurance is entirely taxable to 2% shareholder-employees, while life insurance is tax free up to $50,000 coverage for employees.
Health savings accounts are tax free to regular employees but taxable to 2% shareholder-employees.
Unlike regular employees, 2% shareholder-employees cannot participate in flexible spending accounts.

In addition, family members of 2% shareholders (e.g., spouse, children, parents) are also treated as 2% shareholders for fringe benefit purposes. That means any benefits they receive must follow the same tax and reporting rules as the ones given to the actual shareholder.

Compliance and Planning

Many S Corporations are unaware of these rules and may face IRS adjustment if fringe benefits are not properly reported. If fringe benefits are omitted from W-2 reporting, the IRS may disallow related deductions, resulting in increased taxable income and potential penalties.

If you are an S Corp, planning to start an S Corp, or a 2% shareholder-employee, it’s important to review all the shareholders’ ownership percentages to determine the correct tax treatment of shareholder-employee fringe benefits. The S Corp should decide which benefits to offer and clearly communicate this information to its payroll provider, especially regarding shareholders benefits. Be sure to consult your CPA or refer to the IRS website for fringe benefit guidance.

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This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.