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Submitted by WoodcockPC on Mon, 2019-06-24 13:49

Salary Rules in an S-Corp

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You're in business to make money to feed your family, send the kids to college or drive the sports car of your dreams. But when you're a shareholder in an S corporation, how and how much you get paid can be controversial and a red flag for the IRS.

What is an S corporation?

Businesses are organized in many ways. In an S corporation, business income and losses pass through the business and become part of each shareholder's personal tax return.

Why is that a good thing?

S-corp shareholders, who work as owners and employees, can save money on Social Security and Medicare taxes. The money they retain can be considered a distribution of earnings, which is exempt from payroll taxes.

Even better, S-corp officers and board members decide how much (or little) actual salary shareholders receive. If you own the S corporation where you work, you make that salary decision.

Who and how do S-corps pay?

The IRS is hip to the S-corp salary dance and dodge. In 2000, the IRS inspector general found that 440,000 single-shareholder S-corps paid no salary to the owner, robbing the government of billions of dollars.

The IRS has stepped up auditing S-corps and enforcing salary rules. And this is where compensation can get confusing, because the "rules" are not entirely clear.

The only real IRS guidance is that S-corp shareholders "who provide more than minor services to their corporation … must receive compensation subject to federal employment taxes."

This is where the trouble — and the lawyer bills — may begin. How should S-corps determine, exactly, what is reasonable compensation for services rendered? The IRS suggests looking at the following factors to determine what a reasonable salary would be:

  • Duties and responsibilities
  • Time devoted to the business
  • Training
  • Dividend history
  • Payments to employees who are not shareholders

Another way to determine reasonable compensation is to consider what other people doing the same work in similar-size companies earn. Check employment sites such as Salary.com to determine and substantiate for the IRS reasonable compensation for comparable positions.

S-corp compensation issues can cause huge tax headaches, audits and penalties. That's why we're here. Give us a call, and we'll help you navigate the S-corp compensation waters.

 

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