Discussion:S Corp Owner Salary vs. Distributions
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| {{ForumReplyPost|UserID=DZCPA|Date=9 January 2006|Text=No. He is a part time employee of the S corp. He CAN get more then one W-2 in a year.}} | {{ForumReplyPost|UserID=DZCPA|Date=9 January 2006|Text=No. He is a part time employee of the S corp. He CAN get more then one W-2 in a year.}} | ||
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| + | {{ForumReplyPost|UserID=Casper|Date=9 January 2006|Text=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? | ||
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| + | I appreciate the help. | ||
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| + | }} | ||
Revision as of 23:29, 9 January 2006
Discussion Forum Index --> Tax Questions --> S Corp Owner Salary vs. Distributions
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.
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| 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..). | |
| 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. | |
| 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? | |
| 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. | |
| 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. | |
| 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. | |
| 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). | |
| 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. | |
| 4 December 2005 | |
| I am not that familiar with the preparation of S-copr returns but I was under the imptresson that if a k1 is issued to the owner of an S-corp and the income is reported with self employment taxes being paid would that not cover requirement of salary as long as SE taxes are being paid? Does the salary hae to be in the form of a W2? Can somone answer this question for me ? | |
| 4 December 2005 | |
| Naa, Income to an owner shown on a K-1 is not subject to self employment tax since they are not "self employed". Salaries are shown on a W-2 only. | |
| 5 December 2005 | |
| DZCPA,
Do you know why we are then given an option on the pass through K1 (on the individual tax return) screen to enter self employment income, under other info (17): That section alone was part of the reason that I believed that we were able to choice the option of paying SE taxes on K1 income,as this entry generated an SE tax calculation for the taxpayer..Have I then been mis-using this option? | |
| 6 December 2005 | |
| Naa, Not sure why your program shows that for a S Corp K-1 form. There is no line on the S Corp K-1 for self employment activity. The K-1 is issued to a shareholder of the corporation, not a employee or an outside contractor. S-Corp income does also not qualify as income for IRA or SEP IRA deductions. | |
| 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. | |
| 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. | |
| 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. | |
| 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 | |
| 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. | |
| 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 :) | |
| 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! | |
| 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?? | |
| 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. | |
| 8 January 2006 | |
| One of my clients has S Corp for his side business and he works for large C corporation., this year he already satisfy Social Security payment via W-2 from the C corp. so he would like to “save” on the SS from the S – assuming he will get W-2 from the S corp as well – he will be exempt from his side but his S Corp will still need to pay it’s part to Social Security.
My question is – can he issue 1099 instead of W-2 as Director Compensation subject to SS, that way the S Corp will not pay SS and he will not pay because he already reached the cap…am I missing something? | |
| 9 January 2006 | |
| DZCPA, thanks for the reply! I know that however- because my client is a full time employee (at the C corp.) and the S is for side consultation business - can't he invoice his own S corp. for Management services using 1099? | |
| 9 January 2006 | |
| No. He is a part time employee of the S corp. He CAN get more then one W-2 in a year. | |
| 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. | |
