How to Determine your Salary in an S-Corp
S corporations are a great solution for the right kinds of businesses. However, they come with strict salary rules for their owners.
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, because the bucks they put in their pockets 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 to 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.
It’s not nice to fool the IRS, which has stepped up auditing S-Corps and enforcing salary rules.
And that’s where it gets tricky, because the “rules” are murky.
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 fun — and lawyer bills — begin.
What, exactly, is reasonable compensation for services rendered?
The IRS, always helpful, suggests you look at these 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.