3826 / What special requirements apply to plans covering shareholder-employees of S corporations?

With respect to qualification, plans of an S corporation (whether defined benefit or defined contribution) generally must meet the same requirements applicable to other corporate plans ( Q 3838). The special rules that apply to S corporation ESOPs are explained at Q 3825.

Probably the only significant difference from other entities is in the way that the owner’s compensation is treated for plan purposes. Only wages paid to an S corporation employee-shareholder generally may be included in compensation for purposes of determining contributions, nondiscrimination testing, and classification of key or highly compensated employees. That is, S corporation distributions are not included. In contrast, the K-1 income paid to a member in an LLC taxed as a partnership or a partner in a partnership is treated as contributions for plan purposes. Certain abusive S corporation ESOPs will not be treated as qualified plans, will be subject to prohibited transaction penalties ( Q 3980), and are among the “listed transactions” treated as corporate tax shelters (subject to additional penalties).¹