Salary Rules in an S-Corp
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
- 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.