S-Corp Officer's Salary

Unlike a partner in a partnership, the shareholder’s share of Subchapter S corporation taxable income is not subject to self-employment tax. However, if the shareholder performs services for the corporation, the shareholder must be paid a reasonable wage (subject to FICA, FUTA, and state unemployment taxes). 

Reasonable Wage For Services

The temptation is to pay little or no wages to the Subchapter S corporation shareholder for the sole purpose of reducing Social Security and other employment taxes. This issue was addressed by the 7th  Circuit in the case of a lawyer who incorporated his law practice and elected to be a Subchapter S corporation. The lawyer received no wages during the year but was able to take distributions whenever the corporation had funds available.

When the IRS is successful in re-characterizing distributions as wages, the Subchapter S corporation is subject to all of the employment taxes along with penalties and interest for failure to deposit the taxes, and possible failure to file Forms 940 and 941.

Some factors considered by the IRS and courts to determine if shareholder compensation is "reasonable":

• Compensation paid for similar positions in other companies.
• Shareholder’s background and experience.
• Shareholder’s contribution to profit making.
• Time spent performing services.
• General economic conditions.
• Salary paid to other employees.
• Employer’s financial condition.
• Compensation paid in prior years.
• Comparison of compensation to distributions and retained earnings.

Proposed Regulation §1.1366-3: In addition to challenging compensation paid to shareholders, the IRS will challenge compensation paid to members of the shareholders’ families. If the compensation for services or for use of capital is not reasonable, the IRS will make an adjustment. This adjustment will also carry through to the recipient of the compensation.

 

 

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