S Corporations, also known as an S Subchapter, are a good option for many businesses as it allows a corporation with 100 shareholders or less the benefits of incorporation while allowing business income, losses, deductions, and credit to be passed directly to shareholders. The shareholders then, in turn, report those items on their individual tax returns and pay taxes at ordinary tax rates. Shareholders can be company employees, earn salaries, and receive corporate dividends that are tax-free, with some restrictions, of course.
One caveat to filing under an S Corp is that the IRS scrutinizes how they pay their employees due to the ability to disguise salaries as corporate distributions, thus, avoid paying payroll taxes. For this reason, an S Corp must pay reasonable salaries to shareholder-employees for services rendered before distributions are made. If you are an S Corp owner or officer and haven’t paid yourself a salary, it is imperative that you do so before the end of the year, unless you didn’t take any distributions this year. If you do not pay yourself, your S Corp status could be in jeopardy as it may be terminated. Keep in mind that the IRS expects those wages to be “reasonable compensation for services rendered to the corporation,” not cash distributions, payments of personal expenses, or loans. These wages must be paid prior to other distributions. The IRS has set forth some guidelines to help determine what is considered to be a reasonable salary for the work the officers are doing. A few are:
- Training and experience
- Duties and responsibilities
- Time and effort devoted to the business.
There are many other factors that go into what is considered to be a reasonable salary. A good tax professional, such as Potts & Company will help you determine what is reasonable for your business and the work you do.
Potts & Company can answer any questions you have about your S Corporation, filing, and salary distributions. Acting before year’s end can quickly rectify any noncompliance errors avoiding any adverse consequences. Schedule a consultation with Potts & Company today by calling 479.648.2846.