S corp wages

[Raymond]

I've picked up several clients who have S Corps. Their prior tax preparers all seem to have advised them to pay minimum wages, and take the rest out as distributions. I'm thinking the IRS will step in and reclassify the distributions as compensation. Does anyone have suggestions on what would be a reasonable wage to pay an S corp owner?

[Armando Beaujolais]

Reasonable Compensation

You're right. The IRS will challenge S corporation compensation paid to shareholders. If compensation is really "minimal," the IRS will reclassify the distributions as wages if they look at the returns. Then you have back payroll taxes, interest, and penalties.

Forming an S corporation for purposes of avoiding payroll tax is popular, but the IRS is targeting reasonable compensation in S corporations. The rule is that shareholders must make wages that are comparable to others in the same business. This can be a particular problem for closely held S corporations. If a taxpayer made $100,000 as a sole proprietor, and that person becomes an S corporation and all of a sudden starts taking out $5,000 in wages and $95,000 in distributions, lots of payroll tax is saved but the IRS is likely to see through it.

Can S corporation owners get away with it? Often the answer is yes. That's why so many continue to use S corps to avoid payroll taxes. In fact, most of the court cases I've seen where S corp wages have been recharacterized have been in situations where the wages paid were zero or next to nothing. The bottom line is that there has to be some basis to explain why the wages are where they are. Included in the explanation is what makes the ownership in the corporation so valuable as opposed to the services actually provided by the shareholder.

Ask the client if they would work for the same wages if they were not owners of the corporation.

[oliviao1102]

Hi there..I am confused on an issue and was hoping someone could shed some light. My husband and I opened a business in April and formed an S. Corp. We have a payroll company cut our payroll checks and take the appropriate taxes out. However, are we able to take distributions from the business account out for personal use? If so, do we need to repay that money back? We have been taking the minimum in payroll but if we are low on cash some times we will take a small distribution out to get by until we can cash another pay check. I am concerned that at tax time we will get in trouble for this. As you can see we are young, and uninformed on this, this is all new to us. Thanks for any input you can provide.

[Armando Beaujolais]

Hi there..I am confused on an issue and was hoping someone could shed some light. My husband and I opened a business in April and formed an S. Corp. We have a payroll company cut our payroll checks and take the appropriate taxes out. However, are we able to take distributions from the business account out for personal use? If so, do we need to repay that money back? We have been taking the minimum in payroll but if we are low on cash some times we will take a small distribution out to get by until we can cash another pay check. I am concerned that at tax time we will get in trouble for this. As you can see we are young, and uninformed on this, this is all new to us. Thanks for any input you can provide.

You can take out distributions and they will be nontaxable up to your stock basis (capital contributions plus S corporation earnings passing through on Schedule K-1 [earnings don't include payroll in this situation]).

You need to run, don't walk, to someone who understands the tax ramifications of an S corporation. You're sending money in and out of a corporation. Something that seems innocent could get you into a bad situation if not done correctly. Get some advice.