Discussion:S Corp Owner Salary vs. Distributions

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Discussion Forum Index --> Tax Questions --> S Corp Owner Salary vs. Distributions



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Cpasupport (talk|edits) said:

16 November 2005
We all have to decide at what level reasonable compensation is for S Corp owners. I've used industry averages, what employees are paid, corporate right to profit, IRS standard of living tables, etc. Anything I can to justify the lowest possible S Corp owner salary. I'd love to hear other peoples ideas. Sometimes I feel like I'm too aggressive when I'm listing $15k-$30k for salary for owners making 30k-$100k before salary and distributions, but what do we go with?

What we can get away with? That's probably a little less than what I really feel in my heart is reasonable compensation because I can make some pretty good arguments.

Do we file whatever the client does. I have clients that pay 0-10% of profits in salary. Yes, they are playing the lottery audit game, but the problem is they are winning 99 in 100 times. I heard an revenue agent say that they really don't audit companies under $100,000 (He did not say revenue, profit before salary or profit after salary). I've got one right now that paid $0 salary and $40,000 distribution. Obviously salary should have been paid, but all 941s company W-2s, etc. have already been filed. If I changed distributions to salary where would I even make up the numbers (IRS's job). File as client did the books? He is starting salary now in 2005 per my advice but I'm still looking at his 2004 return (yes it is after the deadline) wondering how I could file an honest return with $0 salary or how to make up any other #s (I also feel that is wrong). What if he paid $6,000 instead of $0. We know $6,000 is unreasonable, but that is the paper trail.


Thoughts.

Snooks (talk|edits) said:

17 November 2005
If you are doing the tax return and they are doing their own payroll and bookkeeping, it would seem to me all you can do is highly suggest that they pay a reasonable salary. If there is no officer compensation, then that line on the 1120S must be zero. The IRS is looking at these lines and are starting to audit these returns. To put something there when there is none, is a big mistake. I certainly have clients that own corporations and their kids are the employees and run day to day operations. If the owner/officer does not physically work in the business, I have no problem with a zero salary. When they are working in the business, then they need to pay appropriatly. Look at the hours they work and wages paid to others. They certainly should not be the lowest paid employee of the business. The amount of the wages need to fit that facts (hours worked, going rate, ect..).

LJACPA (talk|edits) said:

18 November 2005
One general guideline I always use is, never let the salary be less than the distributions. After that, it's anyones guess.

DianeOffutt (talk|edits) said:

22 November 2005
I advise clients of the 60/40 rule, 60 being salary.

LJACPA (talk|edits) said:

23 November 2005
I just had an S Corp. s/h tell me yesterday that he was advised of the 60/40 'rule'. However, is this really a rule, per se, or just a oft-used recommendation?

Mpfllc (talk|edits) said:

24 November 2005
All of the above responses to remuneration for "S" corp owners are reasonable, however LJACPA has the real answer, in that salary should never be less than distributions. In years past IRS has overlooked this requirment in an "S" corporation, but are now beginning to take notice. One way to resolve this issue is to convert to an LLC which has no such remuneration requirement. Although I believe they will close that loophole one of these days. Have already had on audit of an "S" corp where the owner worked full time and the auditor allowed his salary to be substantially less than distributions, but only because it had been done that way for several years. I suspect they, IRS, do not want to face a precident setting issue just yet.

DZCPA (talk|edits) said:

25 November 2005
I do not agree with the distribution rule as noted above. Distributions have no relationship to the amount of time a shareholder spends on the business activity and how much hiring another person to do those tasks might costs. Making a high profit margin on income does not mean the shareholder should have a higher salary signing check or supervising employees. The IRS audits are so low that I do not spend much concern with whether the IRS will audit more returns in the future. I have only seen 3 audits last year out of 1,000 returns filed. Not much to worry about.I usually use a wage of $18 per hour times 2000 hours worked per year equaling $36,000 per year. We have never had a problem yet.

Sheldon (talk|edits) said:

28 November 2005
Seems to be a broad grey area, but I think it will get more attention as the IRS has hired more people. It may be okay for no compensation at times, where the business has not yet been profitable or is a new business for the first year. I then suggest that the owners pay themselves at least what they would hire someone for similar work. As a check on your method, distributions really should have some relationship to capital invested or retained in the business. I think that a straight percentage (like 60/40) may not hold up. Some taxpayers choose to be more agressive than others, but my preference is to have a salary that is based on hours, reasonable rate of pay, and move it up slightly each year (unless business or amount of work decreases). Have your clients put a reason for salary in the annual minutes. That should help document the reason the pay rate was chosen.

Rgreen (talk|edits) said:

2 December 2005
As far as all of the above comments, I am most closely alligned with DZCPA. I don't worry about 60/40 or whether the salary is greater than the distributions. I've never had one of my S Corps. audited, but the feedback I've heard from others is that the IRS has only really raised the issue when the stockholder takes ZERO salary (hogs get slaughtered).

KLRJR16 (talk|edits) said:

4 December 2005
There are more considerations in deciding salary and distributions than i have seen mentioned here. I had a plumber take the salary of his highest paid person. ( $36000 ). He also had $100,000 in profit distributions. My arguement with the IRS was that his salary matched the averages in our region for plumbers and the profit was his dividend as a shareholder. I successfully argued that the other four employees also earned profits for the company. So the circumstances should dictate the salary/dividend decision. If owner is the only worker, it would be hard to argue large profit dividends.You need a rational approach to your decisions, not a standard "rule of thumb". You need to impress on the IRS agent that the shareholder and the company are separate entities and to look at their audit with this in mind. And always, smile, act nice, offer food and drink, and a comfortable working environment for the Auditor.


Tonypa (talk|edits) said:

9 December 2005
I usually just use something reasonable as compared to net income, and I determine this as a year-end salary, unless the owner wants to take salary during the year. I know it opens up for a payroll audit, in that the year-end salary probably could be pro-rated over the year, but I use it at year end as a vehicle to pay their estimated taxes, since withholdings are deemed as paid equally throughout the year, thus reducing the chance of underpayment penalties. Also, I use the amount needed for withholding as another guide for determining the gross salary. This is still sort of unchartered territory, and we are all taking a bit of a chance in whatever method we used. I just think that as long as it looks reasonable on paper, you probably won't be audited. As an aside, a few months ago I read they are trying to pass that S Corp K-1's to participating owners will be subject to S/E tax, just like a partner in a partnership, so this may all be a moot point in the near future.

Cruiser (talk|edits) said:

10 December 2005
The present cases are all concerned with t/p's who paid no salary at all, and the IRS calling all S-Corp income as salary. Reasonable salary seems to be in the eye of beholder.

Pjs (talk|edits) said:

10 December 2005
Mpfllc said to convert the S corp to a LLC. I'd like to know how this is done without triggering tax consequences to the S corp shareholders. Effectively the S corp is liquidated and it's deemed a sale at FMV of the assets, the excess of such over the shareholders basis in the S corp being gain, some ordinary (depr recapture, etc.) and some capital gain.

Sandysea (talk|edits) said:

11 December 2005
I am in need of advice for a client who is a shareholdser/employee of an S-corp. Why would distributions to this s/h be more tax beneficial than payroll? The distributions are high and I am telling the client to pay himself a payroll check to write off distributions to the 40% and to pay enough in income taxes to offset the income from the corporation.

But my question is: Are distributions treated as income in the current year? And if so, are they then taxed at the same rate as income?

Thanks

DZCPA (talk|edits) said:

13 December 2005
Sandy, Distributions are not taxed ever unless they exceed a shareholders basis. What is taxed is the shareholder of a S Corp's share of profit (paid out or retained by Corp). They are taxed the same as wages except there is no social security taxes due on distributions.

Sandysea (talk|edits) said:

14 December 2005
Thank you DX. I realized that the share of income on the K-1 is taxed as income to the shareholders. The basis is what confused me :)

Umk395 (talk|edits) said:

14 December 2005
We prepare over 150 S Corp returns each year. We always advise our clients to pay reasonable compensation. For those who are unable (or unwilling) to determine "reasonable" compensation, we use a 50/50 rule, although we prefer the 60/40 rule. Never once had an audit on the issue. Main reason: The IRS is reluctant to place itself into the role of the DOL. The IRS is responsible for tax compliance, collection, et al. The Dept of Labor sets labor and wage standards. Cross-functionality is not something the US government does well. Also, if you think about it....if the IRS were to re-characterize a portion of the distributions as salary, they would be requiring the taxpayer to INCREASE his expenses! Not a comfortable role for the IRS to be ADDING deductions to the taxpayer's tax return!

Sandysea (talk|edits) said:

15 December 2005
I agree; but the increased salary would wash out in the 1040 return would it not? Yes, it would be deductible for the corporation, but the shareholders would increase their earnings and the tax benefit would not be realized as such in my opinion. The savings would be in the matching fica and unemployment taxes only don't you think?

I do have a client who has taken salary all year but has not made any payroll tax payments nor filed payroll tax returns for the current year. He also has no money to pay any taxes, so my suggestion to him is to close the corporation..it has only been in existence since August and he is not doing anything to be compliant. What are your thoughts on this? As well, his father has a corporation and has been paying his son a fee each week (which should have been treated as salary to the son's corporation) for work he is performing for him. His father takes salary and makes payroll tax deposits for himself, but in case the son closes his corp and does not pay any payroll taxes, would this expose the father to payroll taxes for the son? The son is basically a subcontractor, but it could be argued that he is an employee??

Mkelly (talk|edits) said:

29 December 2005
Please let me know if I can be a resource for your clients. My company has responded to the growing number of conversations surrounding payroll compliancy for S-Corporations. We have introduced a service that will allow pay the owner a salary, deposit the federal, state, and local taxes, file those tax returns, and create the W-2 at year end. We do this for a nominal fee of $30/month. We have helped s-corps all accross the country with this service. Sanysea, I'm sorry I do not have an answer for your question.


Casper (talk|edits) said:

9 January 2006
I briefly read what you've all been discussing... I'm getting a bit confused. I have my first S Corp client. They've been taking a "reasonable" salary all year and have had a very profitable year. Can they take a year-end distribution of profits / dividend distribution (as long as it doesn't exceed net profits or their basis)? I'm thinking a few thousand each. What are the steps involved??? Beginning with the owner/officers cutting themselves a check. It's reported how on the 1020-S? goes to the K-1 then to the 1040? It does NOT get added to W-2? Does it get 1099'd?

I appreciate the help.

Lois (talk|edits) said:

9 January 2006
I am reading a lot about this 60/40 rule. 60/40 of what - - gross income or net income?

DZCPA (talk|edits) said:

10 January 2006
There is NO RULE. Accountants are making their own rule to what they feel is a comfortable allocation. Officer salary in relation to S Corp profit before Officer salary.

LJACPA (talk|edits) said:

10 January 2006
Casper, generally, yes, they can take a pro-rata (based on ownership %) distribution of the profits, which should not exceed basis. There are really no 'steps' involved other than writing a check. Maybe a 'duh' comment, but only owners (who can also be officers) but not officers who are not owners can receive distributions. I assume that when you said '1020-S' you meant 1120S and yes, the distributions are reported on the 1120S, in several different ways. Distributions that do not exceed basis are not reported on Form 1040 and never on the W-2 or a 1099. Please forgive me for saying this, but these answers are very, very basis and general to some potentially very difficult issues. Please find someone to help you prepare this return.

Casper (talk|edits) said:

10 January 2006
LJACPA, Thank you for your response. Yes, I did mean 1120S (typo). Yes, I realize these are pretty basic questions. I thought I knew the answer to but then reading some of the discussions above, started to make me question myself. In the past, I had heard people (owner/officers of course) just write themselves a check. Obviously, it is a distribution not and expense and would therefore basically become subject to income tax when net profits flow thru to the 1040. I didn't mean specifically reporting the distribution on the 1040. Anywho, I appreciate the advise. I plan to have another CPA's assistance definitely. Thank you for your clarity.


Mikelim (talk|edits) said:

5 July 2006
I've always taken the position that "reasonable compensation" would be what an owner would pay to have comparable services performed by another person. I've also taken this without regard to the "intangible" quality that allows this specific owner to generate more revenues and profit than your averatge person.

For example, I have a ticket broker client that grosses $400K/year. He manages and operates the business, with 2 employees. We used a salary of $65K and distributions of $100K because $65K is what he paid himself per year before he incorporated, so he has history. In addition, for the duties that he performs as office manager, $65K would be a very reasonable salary.

Again, never had an audit, but I would be comfortable making this argument to an IRS auditor.

MSTguy (talk|edits) said:

6 July 2006
I was recently at a seminar where the instructor claimed he had a close acquaintance from the IRS who stated S-corp salary "reasonableness" is close to, if not the top, current priority for prospective examinations. He stated they aren't looking for those "slam-dunk" cases where no salary is taken and all distributions. Instead, they're looking for several big and small cases with "close calls". In other words, where salary and distributions might be closer, say 50/50. I don't think using 60/40 rules or any other "safe harbor" is appropriate. Instead, it seems "reasonableness" will first look to industry standards. If there's enough available cash and an owner is paying himself a "reasonable" salary in the eyes of the IRS, then the level of his distributions won't matter, low or exceedingly high. Even though so many clients can play the so-called "audit lottery", always remember that as tax practitioners there are certain regulations (professional standard - such as Circular 230) that do NOT allow you to sign a return if there's a certain percent chance (I don't remember the threshold) that a position won't stand against an audit. Just be careful - not only can your clients hurt themselves, they can hurt you. I don't want to sound paranoid, but caution is in order.


Solomon (talk|edits) said:

29 August 2006
The only valid 60/40 rule is for marked to market 1256 contracts.

DZCPA (talk|edits) said:

29 August 2006
How about the 90/10 rule. 90% of your problems come from 10% of your clients.

Solomon (talk|edits) said:

29 August 2006
Amen!


Diego (talk|edits) said:

12 March 2007
Any advice with recent experience or problems on showing income subject to SE taxes if there were no salaries paid from S Corp in 06, TP made estimated payments to cover for 1040 but there were no witholdings in S Corp so cannot show as officers comp. might be flagged at payrol audit. I was thinking of doing it via management fee to Schedule C. TP working from home so home office use will be on Sched C.


Vickytown (talk|edits) said:

14 March 2007
If a Sub S shareholder takes draws in excess of basis and you know it will probably never be paid back as a loan, how do you report it as taxable income on the K-1? Thanks for any help

JR1 (talk|edits) said:

March 14, 2007
Vicky: I don't believe that it's a K1 item. It goes on Sch. D of your 1040.

Vickytown (talk|edits) said:

14 March 2007
Would it go as a sale of stock with no basis - short term? Thanks for any help


JR1 (talk|edits) said:

March 14, 2007
Vicky, the basis would be whatever you still have invested in stock or loans or undistributed profits...

Vickytown (talk|edits) said:

14 March 2007
Thanks for your help JR


JR1 (talk|edits) said:

March 17, 2007
And there is NO FREAKIN' SUCH THING AS RATIO'S to determine proper salaries......Stop it.

Kevinh5 (talk|edits) said:

17 March 2007
That's one of the first things I teach when I'm teaching S Corp classes.

Jdugancpa (talk|edits) said:

17 March 2007
JR, you must have inadvertantly hit your CAPS LOCK key when you were typing because I am sure you don't feel so strongly about that issue as to cause you to holler at anyone :)

JR1 (talk|edits) said:

March 17, 2007
OH YES I FREAKIN' DO!!!!!!!! And just so you know that I know how to find that key....

CTurner555 (talk|edits) said:

17 March 2007
Just finished a 1120S for a new client. 2 shareholders - husband and wife; not involved in the business. They took distributions of profits of roughly $28,000. Son in law runs business, and receives reasonable salary. Profit around $30,000 flows to in-laws; no salary. JR1, don't turn caps on, I'm getting to my question. I'll be meeting with the client next week to drop off return and asking more questions. If the intent for the distributions is some sort of buy out (New client mentioned that the previous CPA had not asked questions at all when doing the YE; some prior year balance sheet #'s were wrong....has there been any planning?), wouldn't they be better off with a sale of the business? Wouldn't there be capital gain treatment then? Fuzzy mind from all this work; and would appreciate thoughts.


JR1 (talk|edits) said:

March 17, 2007
We can edit out the 2nd, no worries. Your shareholders are fine without salary, tho' since they don't work in the business. And the officer salary line probably has son's on it, so no audit flags. If they want to sell the business, that's a whole 'nuther question. For now, since they're taxed on the profits whether taken or not, they may as well take them anyway. Cap gain would be available if the son wants to buy the stock.


Wwtaxes (talk|edits) said:

20 March 2007
I do about a dozen S Corp returns a year, and they are relatively basic, so when I run into something a little off the beaten path, I tend to get confused. I have a new S Corp client: The husband is the sole worker bee, and the wife is the sole shareholder (apparently to be minority owned). I'm sorry if this is so absurdly basic, but are there any gotchas I have to watch out for if the sole shareholder is not participating, but is married to the only real participant??? I can't really think of anything that I would have to do differently from a more typical' scenario, but it's nagging at me that I'm missing something.

Moneric (talk|edits) said:

20 March 2007
Wwtaxes - if they want to take advantage of the minority ownership then she must be an active participant. They couldn't possible get throught the MBE/WBE registration process without her active participation. Therfore, she would get a salary.

Regarding reasonable compensation - it is different for every S corporation, there is no rule of thumb. It is unlikely that a salary of the max FICA rate will be questioned. I use my gut, or the "smell test" and then look at the situation on a company by company basis. FYI localities must be looking at this too. I had an S corp owner take no salary on company with a loss and take a distribution of 5,000 (clearly prior year profits & to pay parior year taxes!), and the locality wanted to know why she didn't take a salary. OYVEH!

Cdwoodscpa (talk|edits) said:

24 March 2007
Hi, I am new to this board and would appreciate any comments in regard to the situation I have run into. I have an S corporation that is undergoing an employment tax audit (shareholder salaries = Zero). The S corporation is a restaurant with two shareholders. Neither shareholder participates in the business, other than to drive to the restaurant to pick up their monthly distribution check. In fact, one of the shareholders lives 2 1/2 hours away from the restaurant. They have a manager in place (who is a family member, a nephew I think)who handles all aspects of the restaurant. This includes hiring, firing, vendor selection, you name it they do it. And when they cannot get something done, the manager calls me and I help get the matter resolved. The shareholders basically invest the money, get the restaurant open and sit back and collect the profits. Per my phone call with an IRS agent today, he informed me that even minimal services performed by the shareholder would result in some form of salary payment. Well, I do not consider driving to a restaurant to pick up a monthly check a form of "minimal services". I cannot find any IRS law that clearly defines minimal service. All of my research appears to not require the salary if the shareholders do not perform any services for the business. Does anyone else have any experience with this subject and could you point me in the right direction? One of the shareholders has ownership interest in numerous S corporations, (of which he provides NO services - all the businesses are located in a town other than where he lives, usually up to an hours drive to the closest restaurant.) Your comments will be greatly appreciated!

Peteo2662 (talk|edits) said:

24 March 2007
In reading through this thread one topic has not come up which I believe is very important when dealing with this issue. An S-Corporation is a corporation and if it acts like a corporation is suppose to act it makes for a great defense on these type of challanges. Address shareholder/Director/Officer Comp in the minute book. If you are going to have little or no Comp due to Financial constriants indicate that and state why. In other words if the debt ratios of the Corp are way out of line, even shareholder debt, that IS (have aurgued and won) reasonable reason for reduced Comp. The requirement for shareholder comp is judged by what the shareholder actually does and the situation the corporate entity finds itself in. If he is an investor in essence a Small Directors Fee and covering cost will keep you out of trouble with the Service. Accountants tend to get Bogged down with this issue. If a Lawyer Bills 2300 hours and claims 15,000 in w-2 income and 150,000 in distributions he is going to have trouble with an examination. These issues just take a common sense approach, IMHO.

Kevinh5 (talk|edits) said:

24 March 2007
Cdwoods, wrap up the audit, request conference with manager, then appeals if necessary. In your unique case, I think no salaries are appropriate since there are no services, and I think you will win in appeals, but have to go through the administrative levels if you hope to recover your fees in the event of tax court. Good luck. Let us know how it goes and how much time it took to get your truth recognized by the service.

Cdwoodscpa (talk|edits) said:

24 March 2007
Kevinh5, Thanks for the moral support. Another CPA in my office wants me to go straight to the manager on this one. She believes the auditor has already made up his mind before he has even been presented with any facts. We have not even had our initial meeting, only a telephone call up to this point. However, when I explained to the agent that the only participation involved was picking up a monthly distribution check, he indicated that if in the course of picking up the check, he helped deliver food to a table, this would constitute taxable services subject to wages. We both feel this is absurd! Armed with this information, would you immediately contact the agent's manager or would you wait to see how it played out at the initial meeting? I have always been one to treat agents with "peaches and cream" due to the fact I believe you will get nowhere by making an auditor mad. This method has proven successful for me in the past. What is your opinion?

Kevinh5 (talk|edits) said:

24 March 2007
See where it goes, stay calm, you don't want her taking out her frustration on your client by digging until she finds something else.

LAEsquire (talk|edits) said:

31 March 2007
Peteo et al - Thought you might find this interesting, if you haven't seen:

"Johnny" Edwards 1998 tax return (PDF file, $360,000 salary, $5 million S corp profit distrib):

http://www.taxhistory.org/thp/presreturns.nsf/Returns/C7CBBC2B133D704585256F08004F5E7F/$file/edwards98.pdf

http://www.rothcpa.com/archives/000873.php - CPA article discussing the same.


Jdugancpa (talk|edits) said:

20 April 2007
Hey, can't we put a fork in this thread? It's done. Leave it around for good reading, but don't add any more to it. If you have a question about this topic after reading all of this, start a new thread.

Wwtaxes (talk|edits) said:

20 April 2007
I agree that this one is getting hard to follow. I think what we need is an article on this that refers to the various discussions and summarizes the key points. I don't know how the site handles articles, but I know I posted one by accident once! I'd be willing to start it if I could get edits from others.

Kevinh5 (talk|edits) said:

20 April 2007
you use the search field to the left in yellow, with the term "S Corp Salary" or "S Corp payroll" or similar phrase. It's really quite easy, and I've already edited the "Ask a question" page to suggest searching these common topics.


Jdugancpa (talk|edits) said:

18 September 2007
To other late comers to the party: Please post your additional questions to a new thread.


WesR (talk|edits) said:

26 October 2007
Hi I think you should start this question over :) bye

Death&Taxes (talk|edits) said:

26 October 2007
You can say that again, Wes!

btw, I think we will be responding on this thread if this board is still alive in the year 2010.

WIBadgerCPA (talk|edits) said:

26 October 2007
Its not as easy as saying what would you pay someone else to do this job or go to payscale. Each case will have a different answer. If I'm a doctor with no employees or capital purchases, and I make $400,000 based on just my services and services alone, the $400,000 is my reasonable salary. But if I'm a doctor and make $400,000, but have 12 employees and I've bought all kinds of expensive machinery, I should be able to expect some type of return on my employees and equipment. Not all of my income is salary, but some is a return of capital invested in employees and equipment. Maybe now $300,000 is reasonable and $100,000 is income I can distribute. There is no standard amount, but it depends on a case by case situation. Granted, Payscale can help, but it isn't the answer for everyone.

JR1 (talk|edits) said:

October 26, 2007
And you only need to say that once, WI, but this Pack fan couldn't disagree more. Even if you're a solo doc, the question is, what would it cost to hire someone to do your job? Now, if the answer is the same, we're in agreement. In my practice, I'm the only one here except for my various personality splits. BUT, truth be told, I work very parttime. I could hire someone easily to do the work for 50k or less. Much of it's mere bookkeeping. Parttime. No credentials required. So you have to look at every situation. But to say that just because you're solo and earning x it should all be subject to SE tax is mere agreement with the new tax proposal, and flies in the face of reasonable comp case law.


Jdugancpa (talk|edits) said:

30 October 2007
Before adding more questions to this thread because you think yours is so special and unusual that it has not been addressed in this forum before, do you hereby promise, swear and assert that you have read and fully understand the following discussions that also address this issue:

S Corp Salary on Amended Return: Discussion:S_Corp_Salary_On_Amended_Return

S-Corp 2% Shareholder-Employee "Reasonable Salary": Discussion:S-Corp_2% Shareholder-Employee "Reasonable Salary"

S CORP OFFICER SALARY: Discussion:S_CORP_OFFICER_SALARY

S-Corp (Salary pd to oneself): Discussion:S-Corp_(Salary_pd_to_oneself)

S- corp with no payroll, salary or distributions: Discussion:S-_corp_with_no_payroll,_salary_or_distributions

S Corp Officer did NOT take salary - big trouble? payroll?: Discussion:S_Corp_Officer_did_NOT_take_salary - big trouble? payroll?

S Corp - loan repayment or payroll salary: Discussion:S_Corp_-_loan_repayment_or_payroll_salary

S-Corp Owner Reasonable Salary payroll: Discussion:S-Corp_Owner_Reasonable_Salary_payroll

S-Corp salary/draw or payroll: Discussion:S-Corp_salary/draw_or_payroll

S-corp with no salary or payroll to sole shareholder: Discussion:S-corp_with_no_salary_or_payroll_to_sole_shareholder

S-Corp that didn't pay payroll salary to officers: Discussion:S-Corp_that_didn't_pay_payroll_salary_to_officers

S-CORP PAYROLL and salary: Discussion:S-CORP_PAYROLL_and_salary

Business startup corp or llc? S Corp salary: Discussion:Business_startup_corp_or_llc?_S_Corp_salary

SWEEET S Corp salary payroll compensation again: Discussion:SWEEET_S_Corp_salary_payroll_compensation_again

S-Corp no salary or payroll during year: Discussion:S-Corp_no_salary_or_payroll_during_year

The proverbial S Corp Distributions VS Salary: Discussion:The_proverbial_S_Corp_Distributions_VS_Salary

S-Corp-Salary: file a (very) late 941 or issue a 1099?: Discussion:S-Corp-Salary:_file_a_(very)_late_941_or_issue_a_1099?

S-Corp distribution vs payroll or salary: Discussion:S-Corp_distribution_vs_payroll_or_salary

I am certain that a search using other terms than "salary s corp" would bring more hits. So do your homework before asking another question. And, better yet, after your homework is done and you still have a question, start a new thread rather than tacking it onto this one.

EATaxPro (talk|edits) said:

30 October 2007
I believe the IRS' new policy is to appropriate ALL profits as subject to FICA and Medicare, starting the 2007 year. I have not started my review of the rules yet, but remember hearing that stated directly in May of this year.

As such, all distributions will be appropriated to the %owners and subject to social security taxes. It is one of the new methods the IRS has adopted to collect more money for the government.

JR1 (talk|edits) said:

October 30, 2007
EA, c'mon, stop rumor mongering. NOT TRUE! What is true is that the new tax bill proposal contains such a provision. IRS cannot have a policy that flies in the face of tax law as determined by the courts. Do read more.

Gosix (talk|edits) said:

30 October 2007
<stop rumor mongering. NOT TRUE! What is true is that the new tax bill proposal contains such a provision. IRS cannot have a policy that flies in the face of tax law as determined by the courts. Do read more. >

All I know is this is going to suck to have to explain it to the clients, if and when it does happen.


Irsfixer (talk|edits) said:

4 December 2007
What do you think about a strategy of a large bonus every year to the owner that is loaned back at current interest rates? Each year, the interest is paid and the note rolled and a new note is added for the current year. Over time a large amount of potential compensation is converted to interest and repayments are of course tax free down the line.

Johnhuddleston (talk|edits) said:

4 December 2007
I think the IRS would respect that transaction, if all ts are crossed. You are accelerating your SE tax however. A $50,000 bonus this year will increase your SE tax by about $7600 this year, if under the wage base. If interest is 10%, then the note can be increased to $55,000 in year 2. It will take several years before the interest income is sufficient to replace your salary.

It makes more sense if you go over the wage base. I'm concerned that it would pencil out in the end however. Salary does need to be reasonable at both ends. For a company that has before salary profit of $100,000 every year, a $1,000,000 bonus gets you to the point in one year where interest could be used to distribute all profit (assuming 10% interest). You would pay $29,000 extra SE tax in year one. After that, you would only have interest income ($100,000 per year). The problem is that the $1,000,000 salary would not be reasonable in that scenario.

John Huddleston

Bottom Line (talk|edits) said:

5 December 2007
Could this be considered avoidance of tax? The reason this is being done is to avoid tax.

Irsfixer (talk|edits) said:

5 December 2007
It is clearly tax avoidance. Our entire profession is build on the concept.

“Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the Treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.” — Judge Learned Hand, writing for the 2nd Circuit Court of Appeals in Helvering v. Gregory , 69 F.2d 809 (1934)

Death&Taxes (talk|edits) said:

5 December 2007
I've always thought that taxes can be divided into two schools: the Learned Hand vs the Potter Stewart (I can't define pornography but I know it when I see it....substitute tax avoidance for pornography)

Irsfixer (talk|edits) said:

5 December 2007
Tax avoidance is good. Tax evasion is bad. It is the difference that Potter Stewart could have been referring to.

JR1 (talk|edits) said:

December 5, 2007
I do like it. My reservation is that years later, when the profits are extinguished by heavy interest, presumably without much principal repayment, that it will look at that point as something evasive. The owner would be taking hundreds of thousands, let's say, but pay no SS/SE tax and show no profit. While the route to get there was legit, a judge would look at that and cry 'unfair' and legal or not, I expect that that would be that and it would go into the flames. But I do like it! The trick might be to not get too carried away, keeping an eye on some reasonable salary all along, even if on the low end due to lack of profits.

Irsfixer (talk|edits) said:

5 December 2007
I see it more like a ten year strategy for retirement. In ten years the client will have limited activity in the business but have large income essentially from capital reinvested in the business. Eventually, she could take out chunks of principal or sell the company and avoid capital gains to the extent of the note.

Johnhuddleston (talk|edits) said:

5 December 2007
We don't really need to define tax avoidance since it is legal and ethical (except for some specific code sections). It's tax evasion and negligence that we need to worry about.

John Huddleston

CPA1040 (talk|edits) said:

5 December 2007
Somewhat new question relating to salary vs distribution:

If a taxpayer takes the position of not taking all net income as salary in order to avoid SE tax, would it benefit that position in the eyes of the IRS if the taxpayer left the additional cash in the S Corp instead of taking a distribution? Say there is a taxpayer who doesn't need all the cash generated by his S Corp (owned solely by him), and he would like to invest the excess cash. Can he just leave the excess in the S Corp and have the S Corp invest it? Is there any rule about having more than one business purpose - i.e. both a trade and holding investments (S Corp was never a C Corp, so there is no E&P to cause tax on >25% passive income)? Could an S Corp which has a primary trade/business also purchase real estate as an investment?

Death&Taxes (talk|edits) said:

5 December 2007
As soon as you say "in order to avoid SE tax," you've dug yourself a hole, more than likely even if the salary were reasonable. Why doesn't he invest it in a self-directed pension plan, which on top of the salary, might take the balance of the distributable income out in his favor?

Jdugancpa (talk|edits) said:

5 December 2007
Call me stupid, but how is this going to work? An unnamed tax guy opens his new S corp with $1000 put into his checking account. He earns $100k (substitute your own number here) before owner comp. Pays himself $90k, loans back $50K to the corp, goes home, tells wife, "Sorry, honey, we can't take the kids on vaction this year, I had to loan the corp some money. By the way, I think you need to go out and get a part time job until the corp can afford to repay this loan. " "Okay," says Sally, somewhat disappointed, but optimistic about next year. Next year comes, guy earns $120k, pays himself $105k salary, plus $5k interest, loans back $60k to corp. "Sorry, honey, can't do Christmas presents this year, I had to loan the corp money again. Do you think you can up your hours abit this next year? But, hey, this corp seems like a solid investment; I just received my interest check from last year's loan. And not only that, I didn't have to pay FICA taxes on the interest payment." On and on it goes.

Yeah, right. Won't work. If the corp has need for capital, leave it in the corp, pay the income tax (but no SE tax) to grow capital. Down the road, when it is time to sell or liquidate, take a modest bonus and pay the rest out as a tax free distribution of AAA.

Irsfixer (talk|edits) said:

5 December 2007
Making up facts such as loaning ALL the money back so you can't go on vacation and the wife must take a job is silly and does not make a point.

Jdugancpa (talk|edits) said:

5 December 2007
I didn't loan ALL the money back, I loaned slightly over half the amount back. I paid interest at 10%. And, yes, "Illustrating absurdity by being absurd" does make a point in that it shows the logical extension of the discussion at hand. The point is, if the corp has a need to grow capital, an S corp already provides a means of doing that. Grow the capital by leaving the money in the S corp. Don't take the earnings out as salary, pay FICA tax and then loan it back. It makes no sense.

Irsfixer (talk|edits) said:

5 December 2007
Would you rather go into a discussion with an IRS examiner about salary versus distributions with $1,000,000 of undistributed earnings or $1,000,000 in debt?

Jdugancpa (talk|edits) said:

5 December 2007
Last I checked, there won't be any discussions with an IRS examiner about treatment of distributions as wages if the distributions were never paid. If the corp has a reason to accumulate earnings in order to finance growth or expansion I would be happy to talk to the agent about the undistributed earnings. If the corp has no reason to accumulate the earnings, then the person would have been foolish to pay them out as salary and pay FICA taxes on the wages and then loan them back to the corp. If the corp has no reason to accumulate earnings there are undoubtably better places to invest the cash. So we're still back to payment of a reasonable wage and taking the extra as S distributions avoiding the FICA on that portion. Let's not overthink this.

JR1 (talk|edits) said:

December 5, 2007
CPA1040, in my opinion, if the money is NOT taken, I cannot see how IRS has an argument for assessing it for payroll. I have semi-retired clients who, amazingly enough, NEVER taken a dime out of the corp. So I've not worried about payroll. Yet. Now, they can't have their cake and eat it, too, so when they do stop the biz and then start sucking the cash out, I don't think it's fair to then merely call it profit distributions, either. When I get to that day, I'll wrestle thru it. But deferred salaries might be just that, deferred. If you read some of the reasonable comp cases, usually for C corps, much of the basis for heavy salaries later is the deferred salaries when the corp was new. The same thing should apply in the S world, to be fair.

CPA1040 (talk|edits) said:

6 December 2007
Jdungancpa, I'm not sure if your scenario was in answer to my question, but if it was, I think you misread my question. I was never suggesting to take a salary of all the net earnings and then loan them back to the the corporation. Maybe adding numbers to my scenario will make it clearer. Say the corporation nets $200,000 before salary. The owner can comfortably live (and take vacations) on $100,000. Can he take salary of $100,000 and not touch the other $100,000. Actually JR1 already answered my question about how the IRS might view that. The other question is: say the S Corporation is a service corporation like a legal practice. Could the S Corporation invest in property, other companies, etc, even though that isn't it's business purpose?

JR1 (talk|edits) said:

December 6, 2007
Pretty restricted there, since you NEVER EVER EVER NO NOT EVER want RE inside a corp. And an S can't own other corps, right? Well, maybe C's...? And LLC's...

Jdugancpa (talk|edits) said:

7 December 2007
CPA1040, my response was not to your question. I think JR & I are in agreement (though I do not want to put words into JR's "Reply to this discussion" box) that distributions not taken will not be reclassified by the IRS as wages. The answer to your question is, yes, you can do what you have suggested, but to quote JR: "you NEVER EVER EVER NO NOT EVER want RE inside a corp." You're much better off taking a reasonable wage and then taking the S distribution for the rest and doing the investing outside of the S corp. Remember, once you're wage is above the SS limit ($97k for 2007), you're only arguing about Medicare at 2.9%. So take your pick. Pay the wage and be certain the IRS won't make an issue of it or pay the extra $100k as S distribution being relatively but not absolutely certain it won't become an issue.

{{ForumReplyPost|UserID=Johnhuddleston|Date=7 December 2007|Text=I believe an S Corp can own anything but an S Corp.

John Huddleston

Johnhuddleston (talk|edits) said:

7 December 2007
An S Corporation can invest in property, (although it may not be the best place for it). You can have more than one purpose. I don't believe you have any holding company issues with S Corps since it's a flow through.

John Huddleston


Rgtaxservice (talk|edits) said:

10 January 2008
This may be a alittle off topic, but it's relevant and it's something I've thought about.

If a sole owner provides a service, how can a reasonable salary be anything other that what the sole owner (S-Corp) netted? Just as if he were a Sole Prop instead of an S-Corp. How can the reasonable compensation be different for a service provider just because of the entity choice. If consultant makes 200K net, that's what he makes. How can you say that he provided 200K of service, yet the salary is only 75K and the rest is corporate profit when he is the corporation. The corporate product is the owner's knowledge in the service it provides. Revenue would be a direct function of his participation.

I can see how reasonable compensation would make sense for a sole owner (S-Corp) that instead sells a product. His product is widgets. If he profits 200K from selling widgets, I can see a 75K salary and a 125K distribution. The corporate product is the widget. Revenue from sales would not be a direct function of the owner's participation in the same respect.


JR1 (talk|edits) said:

January 10, 2008
Because he's not a sole prop, that's why. The rules are different. For a sole prop, by definition, all income is subject to SE. For corps, it's determined by the salary. There is nothing nowhere that says salaries must equal the profit! So I can say that that consultant shouldn't have a 200k salary if it would cost only 75k to hire someone to do his job. If that's the case, you canNOT make a case that his salary should be HIGHER just because he's providing services. Whether selling services or selling products, a salary is a salary, and whatever is reasonable is what it should be. Since when is it improper in a capitalist nation to earn a profit? Even an obscene one?

Rgtaxservice (talk|edits) said:

10 January 2008
That's just my point. A 200K Sole Prop gets whacked for SE for the whole boat (less limits). The 200K sole owner of the S Corp pays himself 75K and gets the rest as a distribution.

It's just the fact that it's one guy making the money based on his services. It just doesn't make sense.

If it were a S Corp owner with a consulting firm and several employees that netted 200K, I can see his reasonable salary and the distributions. His distribution is the result of the sweat and toil of others. Now that's the capitilist way :)

I understand that the rules are different.

I just broke my one golden rule - "Know the rules, but do not ask yourself why or try to make sense of them". It should a commandment somewhere. I was trying to make sense of the tax code.


MDTaxgal (talk|edits) said:

30 January 2008
Has anyone used a "1099" to report Officer's Wages after the fact on a Corp return and then reported the "1099" income on a Sch C? I had a client come in last year who's prior CPA handled it that way and wondering if that is a solution for some of my late Lucy's who don't even come in the door until after Jan 31.

JR1 (talk|edits) said:

January 30, 2008
Sometimes you have to. I'll have one this year, just no other option it seems...I always seem to have 1.

Szptax (talk|edits) said:

31 January 2008
I have one too - been doing it for years - is the only owner & the only one performing services. Basically he's semi-retired. I tell him every year about the W-2 "rule" & he says heck no - for just me? So.....1099/sch C it is.... This year though, I believe I need to prepare an 8275 disclosure.


TxSrv (talk|edits) said:

31 January 2008
"1099/sch C it is.... This year though, I believe I need to prepare an 8275 disclosure."

You would be disclosing on 8275 that S/E tax per 1040 is overpaid.

Szptax (talk|edits) said:

31 January 2008
overpaid? how so - the SE tax is appropriately paid if all payments to the owner are included on the 1099. For this client I am not making it up - and he only takes maybe 15-18K per year. what would be over stated is corporate income since he can not deduct the employer FICA tax portion. But in my case, he basically takes everything out anyway.

Kevinh5 (talk|edits) said:

31 January 2008
SZ, I believe that the 8275 you are discussing would be attached to the 1120-S stating "Corp deducted officer's salary as compensation on return, but no W-2 was issued or 941's filed, and a 1099 was issued instead. Officer's personal return will reflect a Sch C and SE tax for this amount."

JR1 (talk|edits) said:

January 31, 2008
I think it's nondisclosure anyway. TxSrv himself said just a week or two ago that IRS wouldn't challenge the treatment. That wasn't a green light, merely the practicality of the thing.

Szptax (talk|edits) said:

31 January 2008
I agree that the 8275 would accompany the S corp return (not the 1040) The employee/owner is correctly reporting the information - the the corporation that should have paid W-2 wages. I think that this is a disclosure issue and I was in a seminar recently that also recommended disclosure. It is estimated that 1/3 of items reported in this way being are reviewed. I would hope this disclosure would be sufficient to avoid further scrutiny. Perhaps thats what TXSrv meant - that the IRS wouldn't challenge these items from a practiccal standpoint.

My other concern is the state. I am in PA. I had a client (I will be terminating him shortly) that elected S status as an LLC in 2006. He paid no wages in 2006 & the UC decided to inactivate the account. They did so with the warning that he is now subject to S corp salary rules for anything he might withdraw (including UC). That being said, he established this entity to get a contract that didn't work out & did no business in the LLC for 2006. Unfortunately, for 2007 he decided to start working in the LLC & I suspect play loose with the bank account despite warnings to the contrary.....

Joanmcq (talk|edits) said:

1 February 2008
The IRS may not challenge the treatment, but the state may well do so, because they are being underpaid in UC, disability or whatever else your state may charge.


JayJay (talk|edits) said:

26 April 2008
I know that most audits so far have been from very unreasonable compensation (paying zero salary), but what if the S corp owner is also the sole employee and receives compensation as an independent contractor to a medical clinic...would this change anyone's views? I guess I'm wondering if you are the only reason the company has revenues, can you still justifiably not pay all of the earnings as salary? Let's say the clinic pays $75,000...could I take a salary of $60,000? That doesn't appear too aggressive but the fact that this involves only one employee who performs all the services makes it a little tricky. Do you think the IRS would go after that and try to recharacterize all $75,000 as salary?

Natalie (talk|edits) said:

April 27, 2008
JayJay, I don't quite understand your first question.

As far as the $75k vs $60k, I think the answer would depend on the auditor and the other facts of the audit -- are there other areas that are questionable, is all requested information being provided (or is it like pulling teeth), is the auditor having a bad day, etc.


DZCPA (talk|edits) said:

27 April 2008
Jay Jay, "I know that most audits so far have been from very unreasonable compensation (paying zero salary), "

JayJay, Have any of your clients been audited for this? Have you personally heard about more than 2 or 3 of these audits? I just do not see them happening? Social security taxes is not high on the IRS list of ways to collect revenues for the government. Many companies actually lease "employees" and show ZERO wages on return with no audits.

JayJay (talk|edits) said:

27 April 2008
I guess I did not frame the question very good. I didn't mean to imply I have personally experienced any audits...I have heard of none at my firm. But just from what I have gathered through reading it seems that, to the extent there have been audits in this area (may be a very small #), the situations were of obvious unreasonably low compensation. Anyway, just ignore the first part of what I said...I was really just setting up the discussion for my real question which is about the salary of a single owner-employee who performs all the services of the S Corp.

There is no audit here...this person is a new graduate out of school who just started working as an independent contractor. She is a sole proprietor at the moment and I'm just trying to explore ways to save some SE tax. She is interested in possibly forming an S corp so she could pay herself a salary and not pay SE on 100% of the income of the S corp. This situation is a little different from other S corp businesses I've seen since she would be the only employee and she performs all the services. If she didn't work as much, the S corp wouldn't make any money. So is there any room to maneuver as far as paying a salary and taking some as distributions?

TheTinCook (talk|edits) said:

27 April 2008
I think quite a few of these sole employee audits are going to depend less on the merits, but on both parties willingness to split the difference and call it a day.

Some here advance a replacement value theory, i.e. I can hire a tax pro to do my work and pay him less then I make, but I don't think that argument holds much weight in a pure service business where the nature of the service is highly dependent on the individual's unique characteristics. A key question would be "Does the work have to personally performed by the shareholder?" If the answer is yes, then I don't think you'd have a chance.


Dunno about the coming audit storm. I've heard the rumors about the new crop if RA's being trained in the deadly arts of reasonable compensation, and goodness knows that many of those cases would be a slamdunk for the Commissioner. So I tend to believe the rumblings on this one.

Employee leasing? You've still got to pay payroll taxes on those. Abusive employee leasing, especially involving offshore companies, is a huge tax evasion scam that gathered a lot of IRS attention a few years ago.

Barbie (talk|edits) said:

27 April 2008
JayJay, Are you factoring in the expenses against income? Seems to me that the S-Corp is going to have matching Fica/M-Care plus unemployment tax expenses at the least, plus the cost of tax preparation for the income and payroll tax returns and possibly even state tax. Don't know what other expenses may be involved, but I doubt that the entire $75,000 would be reclassified as W-2 wages. In any event, comparing these types of expenses against sole proprietor cost to see the botom line in each instance might be appropriate in the decision making process.

JR1 (talk|edits) said:

April 27, 2008
JJ, I think what you ought to be considering is the reasonable salary for that position in that area, adjusted for the number of hours worked. For example, if a FT person in that position would be paid 75k, but you work 1/3 time, then I'd take the position that for services, salary should be 25k. The remaining profits are for good business....

Natalie (talk|edits) said:

April 27, 2008
Tin, are you saying that you think there should be no distributions in an S-corp that provides services only with one employee-owner? I tend to agree with JR. Barbie brings up a good point too about the additional cost to have an S-corp.

TheTinCook (talk|edits) said:

27 April 2008
Of course you would take into account expenses into figuring compensation.

I just haven't been able to frame an argument I am comfortable with yet.

Take for example: you're an accountant who is the sole employee/shareholder of an S-Corp that made $50,000 net of expenses. During the audit, you make the claim that the going rate for accountants doing the same volume and type of work is $30,000.

The problem is how to justify the extra 20,000. I couldn't claim with a straight face that the service was worth 30k when, in fact, I made 50k at it. I guess you could claim that the extra income was due to factors other then service, like location.

I could only come up with one sensible argument; that the 20,000 represents the "markup" on the services that employee only gets a part of because he's a shareholder.


I'll leave you spurious example: An new actor has an S-Corp. He hits it big in 2007 and his S-Corp income for acting, net of expenses, is 350k. The average pay for actors of his demographic is only 30k. What do you claim as his reasonable compensation?

JR1 (talk|edits) said:

April 27, 2008
30k. Reasonable comp. OK, I'll go 50k at the higher end of the curve.

RoyDaleOne (talk|edits) said:

27 April 2008
FYI, one of my clients, an attorney, had the IRS audit him and his PA for 2004. The only issue was reasonable compensation. The PA (S Corp) has about $500,000 net income before shareholder salaries. We settled at $90,000 as a reasonable salary, up from $12,000. Note this level is close to the FICA limit at the time. There was no real attempt to arrive at a reasonable compensation by the IRS. It was my impression once the salary was near or reached the FICA limit the salary was acceptable, and on down the road. It was all about the payroll taxes.

JayJay (talk|edits) said:

27 April 2008
Barbie: "JayJay, Are you factoring in the expenses against income? Seems to me that the S-Corp is going to have matching Fica/M-Care plus unemployment tax expenses at the least, plus the cost of tax preparation for the income and payroll tax returns and possibly even state tax. Don't know what other expenses may be involved, but I doubt that the entire $75,000 would be reclassified as W-2 wages..."

Barbie, I agree. There would be some expenses as you say. Also, if the S corp contributes to a SEP that would reduce the net income of the S corp also. So after these expenses plus the salary expense, if you took the rest in distributions it would be a pretty small amount which shouldn't raise any eyebrows.

Thanks for all the input everyone.

Natalie (talk|edits) said:

April 28, 2008
Tin, I'm not as aggressive as JR, but I think there is some room for not taking the whole net as salary. For example, let's say you have a professional who can operate as a sole proprietor or a corporation. The person chooses to incorporate to get better benefits, e.g., health insurance. As an S-corp, the person pays additional expenses that wouldn't even be incurred as a sole prop., e.g., additional payroll taxes, administrative fees, possibly additional state fees, etc. I would argue that those expenses could be removed from the equation before determining with the salary should be. In other words, the salary should be less to make up for those additional expenses.

TheTinCook (talk|edits) said:

28 April 2008
Natalie, I have no problem with taking the expenses off the top. It's claiming only a portion of the remaining profit, that I have issues with.

One example;

An accountant works for an accounting firm. He gets paid $50/hr and his boss bills him out at $100/hr. Overhead attributable to him is $20/hr. The accountant gets taxed on the 50/hr. No problem there.

Say he negotiates a raise of $30/hr. So now he gets paid and taxed on $80/hr. No problem there either, since that's resonable comp for his services, right?

Suppose he doesn't get the raise, so he quits and starts his own practice. He bills his clients at $100/hr and the overhead is the same. Effectively, he's got a raise of $30/hr, but to only claim resonable comp of $50/hr, doesn't seem so reasonable.


I hope that explains some of the disconnect I'm having on the issue. It seems like we're treating the S-Corp as a magic wand, and that doesn't sit right with me.

JR1 (talk|edits) said:

April 29, 2008
It isn't the S corp that's the magic wand, Tin. It's reasonable comp law as established by the courts. It holds true in the S, the C, and the properly bifurcated LLC interest. It just doesn't apply to Sch. C or employees otherwise. There is nothing in the law that requires all profits to be salaried. That being the case, how do we establish what's reasonable? Even in a service business, the owner is entitled to earn a profit. Your confusion is when the employee and the owner are the same person. Separate them and their roles. To go into business for the opportunity to not just earn a higher wage, but a profit, is what is behind the capitalist idea. Your guy above goes into his own practice. What on earth suggests that since he does that he's not now entitled to take a profit?

It's not the S that makes this happen. It's just the most common entity that brings this topic with it. And of course, I stir the pot whenever I can...  :).

Jdugancpa (talk|edits) said:

29 April 2008
Problem is, JR, if he has little no capital invested in the business it is hard to argue the earnings are a return on capital rather than compensation for services.

JR1 (talk|edits) said:

April 29, 2008
They don't have to be a return on capital. They can be a return for taking risk. A return for years of goodwill (tho' obviously not in this case). Return on good positioning in the marketplace. C'mon, that's the reward of ownership, not wages.

Death&Taxes (talk|edits) said:

29 April 2008
But that positioning, that goodwill, dies with the individual. There is no way to quantify it as capital. Do any of we sole practitioners think our business really has a value without us on this earth (or without training someone to take our place, and teaching that person our shtick that brings the people into the office)? The only value is the customer list we create and which our widows and orphans might be able to turn into cash.

Obviously, as JR has wisely noted in other places, his argument holds water when the shareholder's wage is close to full FICA, but that is a matter of expediency. But that is all that is, expediency for both sides.

Wwtaxes (talk|edits) said:

29 April 2008
I'm surprised that every time this is discussed, we overlook the differences that can arise in overhead. Any employer will tell you that an employee costs much more than what they are paid in salary. I have found that small companies can reduce overhead substantially over the bigger ones. One area for a single SH might be office costs if they are working out of their home instead, but there are many others. Contractors get paid a much higher rate than employees, supposedly because of overhead costs and the flexibility that comes with a contracted employee. If a company will hire you as an employee for $50K, but you can contract your services to them for $50/hr and gross $100K and you have managed to keep your expenses to $20K, your reasonable salary should still be $50K. The fact that you run your business more efficiently shouldn't change that.

Jdugancpa (talk|edits) said:

29 April 2008
I have nothing further to add other than: D&T "Do any of we"???? You're the writer amongst us!  :)

Death&Taxes (talk|edits) said:

29 April 2008
I love using 'We' but maybe it should be Wii. Nintendo surely will produce a 'Be a S Corp' game for the console.

Come to think of it, didn't Churchill say "We noble few" or something like that? Next up is #300.


AGG (talk|edits) said:

6 May 2008
I need some real help here. My client is a service provider, sole owner of an S corp, if the client did not provide the personel service there would be no corp. This client has taken NO salary ever, instead has chosen to report the dividends on the 1040, pay SS on the earnings and has chosen to pay into a SEP. This client was just selected for P/R tax audit going back to 2004. What can I do to soften the hit we are about to take for P/R taxes, and any advice on how to handle this audit. When we first started this S corp it was my understanding that as long as SS was paid through the 1040 no payroll was required. HELP!!!

Joanmcq (talk|edits) said:

6 May 2008
How did your client pay the SS?

Joanmcq (talk|edits) said:

6 May 2008
oh, and fill out your profile. First time I got to nag someone!

Death&Taxes (talk|edits) said:

6 May 2008
And after you complete the profile, tell us who is doing the payroll audit?

JR1 (talk|edits) said:

May 7, 2008
Do keep us apprised AGG, since we often suggest issuing a 1099 and picking it up on the 1040 as a one time stop gap when it's a bit late for payroll filings on the prior year.

AGG (talk|edits) said:

7 May 2008
Hi All,

I am a CPA in Los Angeles and have been for some 20 years. This audit is being conducted via mail by Olivia Gonzalez in Fresno. She was really very rude and kept shouting over my questions and insisting that there has been court cases backing up the decision behind payroll taxes.

The SS was paid through the 1040 on form SE. Can we get credit for these taxes paid, since now it would be double taxation? How do I go forward with this audit? She wants all kinds of records going back to 2004. My understanding is that 04 is already out of the audit period. Also it is my practice to let the auditor obtain the 1120S themselfs, other then providing them with copies. Do I need to have a contract stating that the owner/shareholder will pay all taxes through her personal tax return.

Should I request a different auditor or a supervisor, due to the fact that this woman is already too emotional on this case and we really have just begun.

Any input is greatly appreciated.

JR1 (talk|edits) said:

May 7, 2008
Does she even know that you paid SE tax on the money? Of course, that should be credited, and you may just need to explain that the client didn't know better, picked up the SS taxes at least, sorry, we'll be good, and end up with a supervisor. Sounds like it got picked for a match problem, probably showing wages on the 1120S without PR returns?

AGG (talk|edits) said:

7 May 2008
The auditor does know, as I told her. The problem is that we showed no wages whatsoever, only a couple of 1099s that came to some $1,200. for outside providers, for the whole year in all the years in question. Do I ask for a supervison now or wait until she really gets nast, which I expect to happen very soon. Right now the auditor wants info by May 9th, much of which is noexistent, such as corporate minutes. How do you recomend that we minimize any penalties and interest on the P/R taxes, such as FUTA?

Kathyt (talk|edits) said:

7 May 2008
I don't see how a contract would help, it should have went through payroll, it wasn't an option to pay SS tax on the "dividends". It wasn't a choice, it should be on payroll. By dividends, do you mean the distributions or the net profit? Anyway I would take a breath and try to talk to the auditor reasonably, explain that SS tax was paid on the 1040. I would provide the copies of the 1120S's, not sure about 04 though. Worse case if they reclassify as wages just amend the 1040's to reclassify the SE income to wages and get a refund on open years. Put the shareholder on payroll now, to show the situation is corrected now.

Natalie (talk|edits) said:

May 7, 2008
AGG, as far as the minutes go, I worked for a business that was audited for travel-related expenses. They did not have minutes either but had to provide them. They re-created them for the prior 10 years.

JR, aren't you the one who mentioned a while ago that W2s weren't matched with corp returns?

JR1 (talk|edits) said:

May 8, 2008
Nah, wasn't me. I always figured they should be but have never had evidence that they were or weren't.

Wwtaxes (talk|edits) said:

8 May 2008
AGG - my husband's S Corp got audited quite a few years ago bc he didn't show any wages. However, the CPA at the time had set it up so that he paid a management fee to another company and they paid him wages from there. He gets a W2, but it's from the other company. It held up on audit just fine, but it was flagged because the 1120S didn't show any officer compensation. I've never been real comfortable with this setup, but I didn't set it up, and I don't want to change things now. So, even though you've told her you paid on it, she might not have heard you, and it might not be as bad as you think once she realizes that there is no difference in the FICA amounts. You may have a problem with the FUTA/SUTA however.

I have a new SCorp client that paid wages via a W2, but didn't put the HI premiums on it for 2007. He also didn't deduct them either on the 1120S or the 1040. I noticed the error, and combined Fed/State, it's the difference of about $2000 in refunds that he missed. Now I'm in the dilemma of whether to amend just the 1040 and put the HI on line 29, which is not technically the correct way, but in this case makes no difference in the amount of taxes, or to amend everything (W2, 941, 940, 1120S, 1040), which is the correct thing to do, will have the exact same net effect as option 1, but will cost a fortune to do, making it hardly worthwhile. I'd like to just amend the 1040, but given the notice that came out in January, I'm afraid it will raise a red flag. WWYD???


Szptax (talk|edits) said:

28 May 2008
In early 2007, I had a long converstion with a client about taking salary from an s corp. He said he understood & put him in contact with a payroll service, but.... I learned today from his wife that he didn't take any salary for 2007. Any thoughts? my only idea is to pay a fee to him & report it on a schedule C, not correct but takes care of FICA. (Also hw are 50/50 owners and they purchased their building in the S corp BEFORE I became their accountant. He also has done no entry into QuickBooks for the year - this should be fun....)

Jdugancpa (talk|edits) said:

28 May 2008
Take your pick:

1) Gross up his draws for each quarter in 2007, file late 941's, advise your client he will be paying big penalties because he didn't follow your advice. Oh, and get a check from him before doing it, because he probably will not be a client after you're done.

2) Issue a 1099-MISC for distributions taken in 2007. Take the deduction on 1120S, report it on Sch C. Hope for a sympathetic agent who will commend you for making good out of a bad situation.

3) Report all the distributions as S distributions and report all income on the K1. Pay income tax but no SE or FICA tax. Keep head down, hope for the best.

4) Since he didn't follow your advice a year ago, fire him now before investing any more time and/or emotional capital in him.


LohnStar (talk|edits) said:

2 October 2008
What happens when you finaly decide to clean up a mess. Say 2-3 years of not claiming W-2 wages. Either claimed nothing or SE-tax (like 1099. start with 940 and 941 for each year. Then amend 1120-S. Get a reasonable amount for salary. Oh! remember State taxes. Also remember not to create loss on 1120-S with W-2 wages. For California that would DE6's De7's and DE 88ALL's.Next is the 1040-Amended and 540 Amended. Now, What if a client comes in with QBooks and last years 1120-S and W-2's in hand. You look at last years 1120-S and no W-2 income all distribution and/or SE-tax on 1040. You ask for the last last three years of 1120-S same thing going back 10 years. What to do? This is a real question! As of Jan 1 2008 tax preparers penalties have been quadrupled(yes 5X) and accuracy penalties for the clients are $5 + $10 depending on circumstances (which they would gladly like to pass on to us). Well, can you file the last 1120-S with the W-2 wages? Nope!! IRS will use the "catch all" : "known or should have known" to get you for filing a frivolous tax return. You can not put a sand-box around the problem and continue on. Because all/some/most of the numbers in the furture returns will be bogus. OUCH! You have to clean the mess up all the way to the beginning of "Genesis".

Rkrcpa1 (talk|edits) said:

2 October 2008
Huh?

Natalie (talk|edits) said:

October 2, 2008
I thought the same thing Rkr, but it was really late when I read LohnStar's question, and I just thought I misunderstood the post.

One comment I would make is that I would NOT go back to day one to change the returns for salaries that were not taken.


Dianeoffutt (talk|edits) said:

October 17, 2008
This is in response to LohnStar's Oct 2, 2008 post above. What did you finally do with this "mess"?

Dianeoffutt (talk|edits) said:

October 17, 2008
oops...I hit the button to post my reply before finishing my post..sorry guys and gals. I am asking LohnStar what he ended up doing..then I wanted to say what I did with a client, same problems...well, kinda.

I looked at QuickBooks, saw the weekly "payroll" checks, but no 941s, or state DOL, etc compliance. Since the owner of the SCorp (100% owner) INTENT was to pay a "weekly salary to himself" and he setup as Single 2 Dep...I just grossed up the checks and filed late 941s, 940 and W2.

As for preparing his 1120S, K1 and 1040, I simply waited until he paid his payroll taxes and provided me with proof of such. I THEN prepared the income tax returns.

Of course my client was a "two year issue"...NOT 10...so I am not sure WHAT I would do if it went back 10 years. With the new tax preparer penalties a "mistake" , even an honest one can prove costly...in time and money. Maybe you should just file the return and disclose the issue at hand? Is that being "too naive" on my part? I just want to do the honest thing and keep my client (and myself) operating within the law (although I truly wish the IRC could get a bit LESS confusing...ha ha).


Natalie (talk|edits) said:

October 27, 2008
And on that note, I think we should end this discussion. It's getting waaay too long.
  • A question from a person who appears to be asking about his/her own tax situation, without actual experience as a tax pro, has been moved to the discussion linked at the top of this page (see blue box). All related responses have also been moved.


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