Discussion:S corp salary question

The company is a small company who sells merchandise (not service). The sole owner's duty is to run the company, ie manage the employees, sales, purchasing, etc. Let's say the reasonable salary for that job is $30,000. The company's net income (after subtracting cost of goods sold, advertisement, employees salary (not the owner), etc.) is $10,000, which is smaller than the average salary for that job. What shall the sole owner claim as his salary ? Should he declare $30,000 (the average salary for somebody with that kind of job) or $10,000 (his company's net income) ? If the owner declares $30,000 for his salary, that means the business has a $20,000 loss for tax purposes, but in reality it has a net income of $10,000 (again, before the owner’s salary). Will either way, give $30,000 salary that causes the tax loss or $10,000 salary that is smaller than the average salary for the job, raise a red flag ?

Thank you.

T/P lost in district court and appealed. In a surprising decision, the COA refused to pierce the corporate veil and recognized the T/P and S-corp as seperate businesses (T/P did keep good books and records). Accordingly, based on the T/P's "salary" that was "negotiated" from the S-corp, he was entitled to insurance payments for life in that amount due to his "loss of earning potential". It's a somewhat old case and I doubt anyone is willing to permanently injure themselves to see if that's still good law in that circuit.

This is my long-winded way of saying JR1 is correct.

Isn't true that if he doesn't declare a salary, it will raise a red flag, because he is the one running the small company ? The IRS likes to see that you get some salary ? If he does take the $10,000 salary, will it also raise a red flag because it is a lot smaller than then average wage for the job ?

You meant if he doesn't declare any salary, he can use the profit to re-invest in the company, but not for distribution, correct ?

>The 'red flag' is when there are profits with nothing on the salary line, and distributions. If there is profit, give the profit money to salary first, then distribution, correct ? (this is because if you have distribution but not salary IRS may think you are trying to avoid SE tax)

Thanks again.

The Form 1120S instructions put it this way: "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."

FYI

Say he has $10,000 of income, no basis other than what would come from having $10,000 of income. Instead, he choses to pay himself a salary of $30,000. He now has a $20,000 loss, $30,000 of wage inocme, but no basis in the S Corp.

Do you deduct the loss on the 1040 by "netting" the $20,000 loss and $30,000 of wages from the same entity, or is the loss the loss trapped under basis limitations?

Now if a loss at the S-Corp level - where did the $$ to pay him come from - loans? I see no rationalization to borrow $$ to pay a s/h salary.

Bottom line, if minority shareholder doesn't get paid this reasonable salary, minority shareholder has to quit and go find another job. Minority shareholder is also the key employee.

The issue of the moment is whether the S Corp loss is suspended without regard to the W-2 income. The answer seems to be yes, I just can't find anything authorative.

FYI, no distributions to anyone during the year.

1366(d)Special Rules for Losses and Deductions.—

1366(d)(1)Cannot exceed shareholder's basis in stock and debt.— The aggregate amount of losses and deductions taken into account by a shareholder under subsection (a) for any taxable year shall not exceed the sum of—

1366(d)(1)(A) the adjusted basis of the shareholder's stock in the S corporation (determined with regard to paragraphs (1) and (2)(A) of section 1367(a) for the taxable year), and

1366(d)(1)(B) the shareholder's adjusted basis of any indebtedness of the S corporation to the shareholder (determined without regard to any adjustment under paragraph (2) of section 1367(b) for the taxable year).

JR, business was profitable for 20+ years. But the late 2000s were tough in the construction business and they are still trying to recover from builder bad debts, reduction overhead, and competition from big box retailers.

Don't be. The S didn't earn the wages, the shareholder/employee did. As such, this "income" didn't pass through from the S to the shareholder - only the deduction did. Accordingly, the wage income has no effect on stock or debt basis. If it did, we get to an absurd result: I put $30k into S-corp and it is all paid back to me as salary. Basis is: $30k invested, minus $30k pass-thru ordinary loss...or $0. If we were to add the wage income to my outside basis, my basis is now positive $30k. If I shut down the corp at this point, I have a $30k loss deduction (i.e. the amount of my outside basis). How's that? Can I really have $30k in taxable wages, a $30k pass-thru ordinary loss [the pass-thru wage deduction] and another $30k loss stemming from the disposal of my stock? That would be very nice, but very wrong.

Still shocked. The S corporation didn't earn the wages that are added back for business income limitation test for Section 179. A different situation sure, but I often see pointers, comments, etc. that remind me that XXX isn't included because it's not part of the calculation.

The reason it is not mentioned is because as you can now see - it is not part of the S Corp basis calculations which is the first step in determining if passed out losses are either deductible or suspended.

I've learned never to trust anything just because something isn't mentioned that might be mentioned somewhere else instead. Maybe I'm OCD, but I like specific affirmation, particularly with the amount of money I spend on research software.

The good news is I have my affirmation now. Thanks for the help.

Yeah, completely different.

Also, if it is too good to be true - it probably isn't. But think about it - I pay myself a salary - run a loss because of that salary and then get to net the two against each other and pay no tax. Just does not sound right........

The amounts at issue: about $30,000 of reasonable compensation annually in 2007 and 2008.

The hours worked by the stockholder, used as a measure of reasonable compensation, were derived from the store hours listed on the corporation's web site. As a consolation, the Tax Court agreed he was worth only $16 an hour.

http://www.ustaxcourt.gov/InOpHistoric/GlassBlocksUnlimitedMemo.Halpern.TCM.WPD.pdf

From the top of page 4 of the court case: "Petitioner additionally used an unspecified number of day laborers, whom it paid totals of $39,733 and $41,453 in 2007 and 2008, respectively."

As I think about it, maybe the day labor payroll tax problem didn't get to the court because the taxpayer, the petitioner, didn't take it there....