what is reasonable income s-corp lawyer

Option 1 – Easy Method but Harder to Defend: Use a percentage of net income prior to owner salary. This percentage should be at a minimum 30%, but can often range from 30%-50%+. Example: Net income prior to salary of $100k, using this method you would be in the $30k-$50k range for a reasonable salary, with closer to 50% being less risky.

Full Answer

What is a reasonable salary for a S corporation?

Let’s say your reasonable salary is $60,000 and you pay $12,000 in health insurance premiums. You would pay yourself a $48,000 salary but your W-2 Box 1 and Line 7 (Officer Compensation) on your S corporation tax return would show $60,000… however only $48,000 is subjected to Social Security and Medicare taxes.

Can the IRS challenge a reasonable s Corp salary?

The report looks official and uses sources; this is a critical consideration since reasonable compensation is such a squishy thing. In other words, the IRS might challenge your reasonable S Corp salary much like a mall cop with a badge but no gun, and certainly no evidence.

Is S Corp undistributed taxable income from self-employment?

In 1959, IRS Revenue Ruling 59-221 held that amounts of S corporation undistributed taxable income which are required to be included in each shareholder’s gross income do not constitute net earnings from self-employment to shareholders.

What are the tax implications of an S corporation?

S corporation owners are in a unique situation when it comes to federal income taxes. First, a look at why S corporations are different from corporations, and then how to avoid tax issues for owners. The S corporation (S corp) is a special kind of corporation that passes corporate taxes through to the shareholders.

What is considered reasonable compensation for an S Corp?

An S Corp owner has to receive what the IRS deems a “reasonable salary” — basically, a paycheck comparable to what other employers would pay for similar services. If there's additional profit in the business, you can take those as distributions, which come with a lower tax bill.

How is reasonable compensation determined for S corporation employee owners?

The key to establishing reasonable compensation is determining what the shareholder-employee did for the S corporation by looking to the source of the S corporation's gross receipts. The three major sources are: Services of shareholder. Services of non-shareholder employees or.

How does the IRS determine reasonable compensation for S Corp?

In determining what constitutes “reasonable” compensation, the IRS looks at the source of the S corporation's gross receipts and at what the shareholder-employee did for the S corporation to help generate those receipts.

What is considered reasonable compensation?

Section 162 defines reasonable compensation as the amount that would ordinarily be paid for like services by like organizations in like circumstances. It considers both the reasonableness of the total amount paid and the services rendered.

What is a reasonable salary to ask for?

As a general rule of thumb, it's usually appropriate to ask for 10% to 20% more than what you're currently making. That means if you're making $50,000 a year now, you can easily ask for $55,000 to $60,000 without seeming greedy or getting laughed at.

How do I pay myself from my S Corp?

An S-corp offers business owners three basic options for paying themselves: by salary, distributions or both. The right choice depends largely on how you contribute to the company and the company's finances.

Do S corp owners have to take a salary?

If you work for the corporation, you generally must take a salary. An officer who performs more than minor services for a corporation, and who receives remuneration in any form, is considered an employee and is subject to employment taxes.

Can I pay myself a bonus from my S corp?

If an S Corp officer has paid themselves a reasonable salary, the best way to pay out year-end profits is a distribution. Bonuses have to be run through payroll and are subject to Social Security and Medicare taxes.

Can my S corp pay my mortgage?

A corporation cannot pay an employee's mortgage as a fringe benefit because it is not a typical business deduction the employee would incur on his own, according to the IRS.

How is S Corp income calculated?

Divide the taxable income from IRS form 1120-S by the number of total shares. For each individual shareholder, multiply the result by the number of shares they hold. Complete Schedule K, which is the form the corporation must file to list how much income is attributable to each shareholder for the taxable year.

Can I 1099 myself from my S Corp?

The S Corporation must also prepare and file Form 1099-DIV reports. Sent to the IRS as well as each shareholder, this form reports any dividend distributions paid to stockholders. As an employee and taxpayer, you will receive a W-2, a Schedule K-1S and possibly a Form 1099-DIV from your business.

What is excessive salary?

EXCESS SALARY means the excess of an Eligible Employee's Salary over his Recognizable Salary. Excess Salary Per Pay Period shall mean the Excess Salary earned in any Pay Period in the Supplemental Plan Year after the Recognizable Salary limit has been reached.

How S Corporation Owners Try to Avoid Taxes

Some S corporation shareholders who are officers of the company attempt to avoid paying employment taxes by minimizing the salaries and bonuses the...

What The IRS Says About S Corporation Employees

The IRS states specifically that corporate officers are employees and that companies must comply with all employment laws in relation to these empl...

What Is A For An S Corp Owner/Employee?

To find a reasonable salary for an S corporation owner/employee, consider how you would find a reasonable salary amount for any new employee. The I...

Using Comparable Salaries to Back Up Your Salary Figures

Another way to determine a reasonable salary for corporate officers is to look at what other companies of similar size and type pay for such servic...

Reporting Officer Salaries to The IRS

Each year, when you complete the income tax forms for your corporation or S corporation, you must report corporate officer salaries if the corporat...

How does S corp pay work?

How S Corporation Employee Pay Works. An S corporation officer (president, chief operating officer, etc.) is considered an employee and payments they receive for their services as an employee are considered wages. This person is also an owner/shareholder but each of these roles is separate. 1 .

What is S corp?

The S corporation (S corp) is a special kind of corporation that passes corporate taxes through to the shareholders. Then, the shareholders report this income on their personal tax returns and pay taxes on their total combined income at personal tax rates. 1 

Can you split profits and take them as a distribution?

They would like to split the profits and take them as a distribution, to avoid self-employment tax, but since they work in the corporation, they must first take a "reasonable" salary. The IRS can reclassify payments to shareholders from distributions that weren't correctly classified and call them wages. These wages are then subject ...

Do officer salaries help with IRS?

Your ability to prove that officer salaries are reasonable will help keep you on the right side of the IRS when it comes time for them to review your company's tax returns.

Is medical insurance taxable for corporate officers?

If your company pays health and accident insurance premium s for these employees, you must include them as taxable wages for the employee.

Do S corp officers have to pay wages?

S Corp Officer Wages Must Be Reasonable. The IRS requires that 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.".

What are the factors that determine reasonable compensation?

“Some factors in determining reasonable compensation: 1 Training and experience 2 Duties and responsibilities 3 Time and effort devoted to the business 4 Dividend history 5 Payments to non-shareholder employees 6 Timing and manner of paying bonuses to key people 7 What comparable businesses pay for similar services 8 Compensation agreements 9 The use of a formula to determine compensation”

Is it reasonable to be a taxpayer?

Taxpayers are left to take a defensible position and define “reasonable” for themselves. The problem is what is reasonable in the eyes of the taxpayer may not be reasonable in the eyes of the IRS.

Do S corporations pay reasonable compensation?

“S-corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee offers to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly”

Who was the only accountant working for the S corporation?

Spicer was the only accountant working for the firm and it was owned 50-50 with his wife. He only received dividends, and claimed to donate his services to the S corporation. The court held “The Federal Insurance Contributions Act and Federal Unemployment Tax Act both define ‘wages’ as ‘all remuneration for employment… that the form of payment is immaterial… [therefore] the only relevant factor being whether payments were actually received as compensation for employment.”

Does S corp salary increase?

As your S Corp income increases, the reasonable S corp salary paid to the shareholders do not necessarily increase on a pro rate basis. In other words, if you peg your salary at $60,000 and that is supported with labor data, your salary does not double just because your net income in your S corporation doubles.

What happens if the IRS reviews compensation of S corp owners?

If the IRS reviews compensation of S-corporation owners and decides that the salaries being paid are not reasonable (meaning “too small”), then it will reclassify other compensations and deem them as wages. Other compensations are generally dividends, but they can also be payments for healthcare, insurance, utilities and other such expenses.

What is considered reasonable compensation?

The IRS does not provide specific guidelines for what is considered reasonable salary for an S-corporation. However, various courts have ruled on the issue, and the following factors have been used to determine reasonable compensation: 1 Training and Experience 2 Duties and Responsibilities 3 Time and Effort Devoted to the Business 4 Dividend History 5 Payments to Non-Shareholder Employees 6 Timing and Manner of Paying Bonuses to Key People 7 Comparable Salaries at Other Companies 8 Compensation Agreements

What happens if you have ten years of experience in your field and pay the recent college graduate?

If you have ten years of experience in your field and pay the recent college graduate you just hired a larger salary than your own, the IRS is going to have some questions about your salary practices.

Is it necessary to have your salary the same as other people?

It is not necessary for your salary to be exactly the same as that of other individuals in your position. After all, salaries are weighed against a host of factors. There should be, however, a fair degree of parity. The wider the margin of difference, the more likely it will be that the IRS will determine your salary is insufficient.

Is Joe's salary unreasonable?

After an IRS audit, it was determined that Joe’s $30,000 salary was unreasonable. The IRS determined that a reasonable salary for Joe’s position was $100,000. Thus it reclassified $70,000 of Joe’s dividends, turning them into wages. Joe is now required to pay federal income taxes on $100,000 instead of only $30,000.

Who was the sole shareholder of an S corporation?

Radtke was the sole shareholder and director of an S Corporation, a law firm. Instead of taking a compensation for the year in question, he withdrew $18,225 in dividends. The IRS argued that since Radtke was the sole significant employee, his dividend was salary. The district courts sided with the IRS.

Who sided with the IRS?

The district courts sided with the IRS. Although rare, there are instances where the shareholder victoriously defended their position. A district court ruled the IRS attempt to recharacterize the distributions as "arbitrary and capricious.".

What is shareholder employee?

Shareholder-employees are corporate officers who contribute significantly the day-to-day business operations. The officers would rather receive compensation as an investor rather than get paid a worker's salary.

How much Medicare tax do self employed people pay?

On the other hand, self-employed people pay the entire 10.4% Social Security which is taxed on the first $106,800, and they pay 2.9% Medicare tax on all self-employment income.

Do dividends pay payroll taxes?

If you are an S corporation shareholders, you may enjoy dividends. If you receive your profits as compensation, you are subject to payroll taxes. On the other hand, dividend distributions are not subject to taxes.

Paying reasonable compensation

Before nonwage distributions are made to an S shareholder, reasonable compensation must be paid to any S shareholder providing services to the corporation.

Officers and shareholders

Taxpayer arguments that payments by an S corporation to an S shareholder are attributable to his or her status as an officer and shareholder, rather than his or her status as an “employee,” have been rejected by the courts.

Family members

If a family member of one or more S shareholders renders services for, or furnishes capital to, the S corporation without receiving reasonable compensation, the IRS may determine any adjustments necessary to reflect the value of the services rendered or capital furnished.

What is reasonable?

In determining what constitutes “reasonable” compensation, the IRS looks at the source of the S corporation’s gross receipts and at what the shareholder-employee did for the S corporation to help generate those receipts. The three major sources of gross receipts are services of shareholders and nonshareholder employees, capital, and equipment.

Steps to take

When preparing a tax return for an S corporation, the underlying workpapers should include detailed documentation that supports the payment, or nonpayment, of wages to an S corporation shareholder-employee.