| Any salary to an S corporation shareholder-employee | | | | amounts are reasonable compensation for services |
| that is below a reasonable amount is a red flag to the | | | | rendered to the corporation.” |
| IRS and subject to IRS scrutiny, especially when the | | | | There are no specific guidelines for reasonable |
| salary is zero. The IRS not only attempt to collect total | | | | compensation in the Code or the Regulations. The |
| FICA tax and FUTA tax, but it may also collect | | | | various courts that have ruled on this issue have |
| penalties from the corporation for not filing its | | | | based their determinations on the facts and |
| employment tax returns (Forms 940 and 941), for late | | | | circumstances of each case. |
| deposit of the employment taxes, and also for failure | | | | Some factors considered by the courts in determining |
| to withhold income taxes on | | | | reasonable compensation: |
| shareholder-employee’s salary. IRS may also | | | | Training and experience |
| impose penalty upto 20% for negligence, careless, | | | | Duties and responsibilities |
| reckless, or intentional disregard of the rules and | | | | Time and effort devoted to the business |
| regulations. Recharacterization of distributions and | | | | Dividend history |
| loans as salaries can seriously impact cash flow of | | | | Payments to non-shareholder employees |
| Shareholder or an S Corporation. | | | | Timing and manner of paying bonuses to key people |
| When S corporation officers perform services for the | | | | What comparable businesses pay for similar services? |
| corporation, and receive or are entitled to receive | | | | Compensation agreements |
| payments, their compensation is generally considered | | | | The use of a formula to determine compensation |
| wages. Subchapter S corporations should treat | | | | Medical Insurance Premiums treated as wages. |
| payments for services to officers as wages and not | | | | The health and accident insurance premiums paid on |
| as distributions of cash and property or loans to | | | | behalf of the greater than 2 percent S corporation |
| shareholders. | | | | shareholder-employee are deductible by the S |
| Any officer of a corporation, including S corporations, is | | | | corporation as fringe benefits and are reportable as |
| an employee of the corporation for federal | | | | wages for income tax withholding purposes on the |
| employment tax purposes. The fact that an officer is | | | | shareholder-employee’s Form W-2. They are not |
| also a shareholder does not change the requirement | | | | subject to Social Security or Medicare (FICA) or |
| that payments to the corporate officer be treated as | | | | Unemployment (FUTA) taxes. Therefore, this additional |
| wages. S corporations should not attempt to avoid | | | | compensation is included in Box 1 (Wages) of the |
| paying employment taxes by having their officers treat | | | | Form W-2, Wage and Tax Statement, issued to the |
| their compensation as cash distributions, payments of | | | | shareholder, but would not be included in Boxes 3 or 5 |
| personal expenses, and/or loans rather than as | | | | of Form W-2. |
| wages. Courts have consistently held that S | | | | A 2-percent shareholder-employee is eligible for an |
| corporation officer/shareholders who provide more | | | | AGI deduction for amounts paid during the year for |
| than minor services to their corporation and receive or | | | | medical care premiums if the medical care coverage is |
| are entitled to receive payment for services are | | | | established by the S corporation. |
| employees whose compensation is subject to federal | | | | We have considered the situation where an S |
| employment taxes. | | | | corporation is paying reasonable compensation to its |
| There is an exception for an officer of a corporation | | | | shareholder-employee. The motive and desired tax |
| who does not perform any services or performs only | | | | position of IRS and taxpayers might be opposite for a |
| minor services and who neither receives nor is entitled | | | | C Corporation. IRS always scrutinize paying more than |
| to receive, directly or indirectly, any remuneration. Such | | | | reasonable compensation in case of a C Corporation, |
| an officer would not be considered an employee. | | | | while paying less then reasonable compensation in |
| What’s a Reasonable Salary? | | | | case of an S Corporation. |
| The instructions to the Form 1120S, U.S. Income Tax | | | | Article Source: |
| Return for an S Corporation, state “Distributions and | | | | ARE YOU PAYING TOO MUCH FOR |
| other payments by an S corporation to a corporate | | | | ACCOUNTING? FIND OUT NOW... |
| officer must be treated as wages to the extent the | | | | |