Compensation - S-Corp Shareholder

[Forensicacctnt]

Client is a very smart young man, 18 years old, who has been very successful with a game played via the internet. He has a profit year to date of about $150,000. He and his parents asked me about setting up an S-Corp; he is currently a sole proprietor (1040 Schedule C). He has reviewed information about S-Corps and raised the question about receiving some compensation as a non-wage distribution. I explained to him about reasonable compensation which he must determine for this type of business he is in. More recently, I have read in a tax reference if the gross receipts and profits are associated with the shareholder's personal services, then most of the profit distribution should be allocated as compensation. His only asset is a computer and there are no other employees. He does use some independent contractors.

My question: would he be allowed to issue any non-wage distributions (not subject to SE tax) or not to himself?

I appreciate any guidance on this matter.

[Uncle Sam]

Is this "game played on the internet" a form of gambling in which you'll need to explore the professional gambling tax rules?

[ATSMAN]

>> More recently, I have read in a tax reference if the gross receipts and profits are associated with the shareholder's personal services, then most of the profit distribution should be allocated as compensation.

I always caution my clients about this issue. Some want to take a token amount as salary. I had a real estate broker who wanted to take just the min. wage for salary!

[Forensicacctnt]

Compensation - S-Corp Shareholder

>> More recently, I have read in a tax reference if the gross receipts and profits are associated with the shareholder's personal services, then most of the profit distribution should be allocated as compensation.

I always caution my clients about this issue. Some want to take a token amount as salary. I had a real estate broker who wanted to take just the min. wage for salary!

Thank you for the information.

Carl

[ATSMAN]

TCJA Impact from Nolo.com article

The Tax Cuts and Jobs Act (“TCJA”) which went into effect in 2018, further complicates the S corporation employee wage equation. S corporations remain an effective means to avoid Social Security and Medicare tax under the new law. However, the TCJA instituted a new pass-through tax deduction that S corporation owners can take advantage of. Starting in 2018, owners of S corporations and other pass-through entities may deduct up to 20% of their net business income from their income taxes.

You qualify for the 20% deduction only if your total taxable income for the year is less than $157,500 (single) or $315,000 (married, filing jointly). If your taxable income is greater than $207,500 (single) or $415,000 (married), you don’t qualify for the pass-through deduction at all if you are involved in a personal service business, such as accounting, law, health, consulting, athletics, financial services, and brokerage services. If you’re not involved in such a service business, your deduction is limited to the greater of (1) 50% of the W2 wages you pay employees, or (2) 25% of wages plus 2.5% of the cost of your business property (but the deduction may never exceed 20% of your business income).

The employee wages S corporation owners pay themselves appear to count for purposes of the pass-through deduction. Thus, in cases where the pass-through deduction is based on W2 wages, it is in an S corporation owner’s interest to pay himself or herself more employee wages than under prior law when there was no pass-through deduction. Tax experts have calculated that 28.57% of business income should be paid as employee wages to maximize the pass-through deduction. Why not pay even more as wages? Paying more actually results in a smaller deduction because the total pass-through deduction may never exceed 20% of business income. Employee wages are a business deduction that reduces business income.

[DMICPA]

With that much income, it would be hard to say that no salary was warranted. Who was doing the work? The Company is running with no employees.
Some type of reasonable salary should be paid as compensation. To switch from a Sole Proprietorship to an S-Corp. are your going to start over or perhaps consider a 351 transfer.

May also form an LLC and elect to be taxed as an S-Corp.