Discussion:S-Corp salary/draw or payroll

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Discussion Forum Index --> Consumer Questions --> S-Corp salary/draw or payroll


TaxTalker (talk|edits) said:

8 January 2007
How does an S-Corp 100% shareholder who performs substantial services for the business take money out of the S-Corp? Is the owner REQUIRED to take a SALARY with payroll taxes, unemployment insurance, workers comp, etc.? Or can the owner just take "draws" (write checks to himself) and record it as a distribution (that is NOT recorded as an expense to the company)? If the business is profitable in 2006, won't the profits pass through to shareholder on his K-1 and be taxed as self-employment income on his 1040?

Bottom Line (talk|edits) said:

8 January 2007
Please complete your profile. One of the big advantages of an S-corp is that the profit is not subject to SE (self-employment) tax. That said - the owner should take a "reasonable salary" for his work for the business. There are several threads related to the definition of "reasonable salary". The owner takes a "reasonable salary" with all the related payroll taxes and reporting. Any other money taken out of the company is taken as a draw and is not subject to SE tax.

Blrgcpa (talk|edits) said:

8 January 2007
Draw is a term used for a sole prop, not an s corp. names count.

The owner must be on p/r with all the required p/r taxes w/h and paid.

If the Accum Earning acct shows a profit, then the shareholder can take a non taxable distribution.

W/o p/r the irs can say you evaded taxes and that is illegal.

Jdugancpa (talk|edits) said:

9 January 2007
I'm with Bottom Line, hoping to see your profile. How does one going by the name "TaxTalker" not know this rather basic point of taxation?

Will (talk|edits) said:

9 January 2007
Also taxtalker, the second most popular discussion on the site is devoted to your query: Discussion:S_Corp_Owner_Salary_vs._Distributions .

Blrgcpa: the tax assessment on distributions from an s-corp is based on the shareholders basis in the shares, not Accum Earnings. By definition as a pass-through entity an s-corp cannot accumulate earnings. Perhaps you were refering to the accumulated adjustments account?


William Price, EA | Portland, OR - Talk to me

Jdugancpa (talk|edits) said:

9 January 2007
Will, what is AAA if not an accumulation of earnings? It is, after all, part of Retained Earnings. Being a pass-thru entity does not mean it cannot accumulate earnings. It just means that the income does not get taxed at the entity level but passes through the entity and gets taxed to the owners, be they stockholders or partners or LLC members.

Will (talk|edits) said:

9 January 2007
I certainly can see AAA being viewed as retained earnings. Many things in theory would effect the AAA and not effect retained earnings under accounting methods widely used, (although all would effect equity). I could be wrong on what Blrgcpa was referring to as I do not understand describing a retained earnings account as profitable. My point that shareholder adjusted basis determines taxability of s-corp distributions still stands though. Sec. 1368 Not a retained earnings account balance or deficit.

Will

Will (talk|edits) said:

9 January 2007
umm, I am 100% positive that a pass-through entity cannot accumulate earnings (after pass-through election is made in the case of corporations). They are passed through every FY, taxed at the shareholder/partner level, and added to SH/partner stock basis. We are on the same page I think but using different terms. Probably my fault...


EDIT: After browsing the 1300's in vain for something to hang my hat on in regards to the accumulated earnings issue, I think I figured out were my confusion lies, and that is in the difference between the terms Accumulated Earnings and Undistributed Earnings. I have viewed them as interchangeable and that is perhaps in error. I learned early on that an S-corp could not pay dividends because it did not have undistributed earnings. I broadened that concept to encompass accumulated earnings as well. Thanks for the feedback Jdugan.

Will

Jdugancpa (talk|edits) said:

9 January 2007
Will, couple more things to think about. If you take off your tax hat and put on your financial statement reporting hat, there is no such thing as AE&P or AAA or S distributions, there are only retained earnings and dividends. So, from a GAAP point of view, S distributions are dividends, although they are separately defined for tax purposes. Additionally, if you use Pro Series 1120S (and other tax programs I suspect), you will see a Schedule M2/Retained Earnings Worksheet that reconciles all of the components of retained earnings, including AAA, Other Adjustments Account (whatever the heck that is!), Shareholders Undistributed Taxable Income, Accumulated Book/Tax Differences and Retained Earnings While a C Corp (i.e., AE&P, roughly speaking).

Blrgcpa (talk|edits) said:

1 April 2007
On a sched there is no p/r for the owner. The net income is subject to se tx. You will have to correct the W-2.

As for prior years, many hair dressers "rent" the chair from the salon and are in fact self-employed.

As for Will's comments: The AAA is basically a sub acct of R/E. It shows the accum earnings of the s corp. In order to make a distribution of any kind, this acct must have a credit balance. Then the distrib is make according to the shares o/s.

Cpathatsings (talk|edits) said:

24 July 2007
As one of the previous discussions stated, a reasonable salary has to be taken. I have a professional client who is a sole proprietor who makes about 600,000 and pays self employed Social Security Tax on maximum limit and self employed medicare tax on 92.35 % of the 600,000. This professional produces over 1 million of revenue. As a sole proprietor my client takes a draw of about 600,000. You hear people advocate S corp where in this case take enough salary to cover Maximum Social Security limit and take the rest as a distribution to avoid the Medicare tax. I think this is dangerous to do because I know the IRS scrutinizes this and if an S Corp Return showed 100,000 salary and 500,000 of distributions, that would really be a red flag and questioned especially with this professional producing over 1 millon of revenue. In this case, I think it is obvious the 100,000 salary would not be reasonable. Any thoughts would be appreciated.

Bottom Line (talk|edits) said:

24 July 2007
This is where "reasonable salary" comes into play.

Death&Taxes (talk|edits) said:

24 July 2007
Any recommendation for a 100K salary and 500K distribution would be almost a guarantee of losing a client when and if IRS does enter the scene, especially since apparently he has demonstrated that he can earn 600K. Unless he is boy wonder, it would have to be assumed that his fellows in the profession could earn that money also. What purpose would the bifurcation of his income serve? To save 15K in medicare tax? I would bet it might cost that much in fees to defend the allocation in audit, and perhaps in court.

Another point: by lowering his salary to such levels, he cannot take advantage of the maximum contributions under pension plans. Depending on his age, I suspect an actuary could whip up a very large defined benefit contribution for him, whether using salary or Sch C earnings.

KatieJ (talk|edits) said:

24 July 2007
There are a number of ways to determine a "reasonable salary," none of them precise, but one way I've looked at it is this: What is it that produces the income of this corporation? If 100% of the corporation's gross receipts arise from the personal services of the sole stockholder, then it is pretty hard to justify much less than 100% of the pre-salary profit as salary. On the other hand, if some of the corporation's income arises from the use of property (perhaps high-tech equipment owned by the corporation), the services of other employees, etc., then obviously not all of the net income is attributable to the owner's services.

Another way to look at it is what a third party would pay the stockholder to perform the same services as an employee, or what the stockholder would pay someone else to do it.

Death&Taxes (talk|edits) said:

24 July 2007
This may date me, but back in the days when rates were above 50%, but earned income taxed at no more than 50%, auditors actually could do such a test. I seem to recall a stationery store where the auditor looked at the inventory falling all about him and wanted to classify some of the Schedule C profit as being earned from capital. I believe that was before ERTA in 1981.

In the current question of Mr. Hastings, I took it that a "professional" was more than likely providing services, though Katie's point could well apply to those in medicine with expensive equipment.

JR1 (talk|edits) said:

July 24, 2007
When Courts address this, they're looking at a couple additional things. What is a comparable salary? This is answered by going to web sites like www.payscale.com or www.salary.com and entering the info for your area, being very careful to find a job description that fits. Other things to consider are the background, training, and experience of the service providor. And, how long the business has been in existence. After many years, goodwill alone generates a good amount of revenue. If the providor has other employees, or has cut back their hours, those are indicators that there are other revenue generators other than personal services. The amount of profit really is fairly irrelevant. Whether the salary is reasonable or not is what matters. The more homework done and documentation the better. Usually, at your client's level, you max the salary for pension purposes, and then let the rest flow thru as profit. I can't imagine much argument over the 2.9% medicare tax.

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