Discussion:S Corp Owner Salary vs. Distributions
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| {{ForumReplyPost|UserID=Jc|Date=26 August 2006|Text=Sure that's a ton of cash and all, but his business is actually illegitimate. This kind of thing made tech news a few months back, since to create an account for this type of online game you have to agree to terms and conditions, the most prominent of which is that you may not sell virtual currency for hard currency. It was smart for this chap to incorporate purely for liability reasons, forget that he's not saving any tax money since he's maxing out his SS wage base. If whoever runs this particular game decides to bring suit, it will be nice for him to at least be able to attempt to protect his personal assets behind the corp, though from what I've read, it's unlikely that the protection will really hold up considering the owner and only shareholder of the business was willfully violating a legal agreement for profit. }} | {{ForumReplyPost|UserID=Jc|Date=26 August 2006|Text=Sure that's a ton of cash and all, but his business is actually illegitimate. This kind of thing made tech news a few months back, since to create an account for this type of online game you have to agree to terms and conditions, the most prominent of which is that you may not sell virtual currency for hard currency. It was smart for this chap to incorporate purely for liability reasons, forget that he's not saving any tax money since he's maxing out his SS wage base. If whoever runs this particular game decides to bring suit, it will be nice for him to at least be able to attempt to protect his personal assets behind the corp, though from what I've read, it's unlikely that the protection will really hold up considering the owner and only shareholder of the business was willfully violating a legal agreement for profit. }} | ||
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| + | {{ForumReplyPost|UserID=Jc|Date=26 August 2006|Text=My apologies, wrong topic :)}} | ||
Revision as of 19:58, 26 August 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. | |
| 9 January 2006 | |
| I am reading a lot about this 60/40 rule. 60/40 of what - - gross income or net income? | |
| 10 January 2006 | |
| There is NO RULE. Accountants are making their own rule to what they feel is a comfortable allocation. Officer salary in relation to S Corp profit before Officer salary. | |
| 10 January 2006 | |
| Casper, generally, yes, they can take a pro-rata (based on ownership %) distribution of the profits, which should not exceed basis. There are really no 'steps' involved other than writing a check. Maybe a 'duh' comment, but only owners (who can also be officers) but not officers who are not owners can receive distributions. I assume that when you said '1020-S' you meant 1120S and yes, the distributions are reported on the 1120S, in several different ways. Distributions that do not exceed basis are not reported on Form 1040 and never on the W-2 or a 1099. Please forgive me for saying this, but these answers are very, very basis and general to some potentially very difficult issues. Please find someone to help you prepare this return. | |
| 10 January 2006 | |
| LJACPA, Thank you for your response. Yes, I did mean 1120S (typo). Yes, I realize these are pretty basic questions. I thought I knew the answer to but then reading some of the discussions above, started to make me question myself. In the past, I had heard people (owner/officers of course) just write themselves a check. Obviously, it is a distribution not and expense and would therefore basically become subject to income tax when net profits flow thru to the 1040. I didn't mean specifically reporting the distribution on the 1040. Anywho, I appreciate the advise. I plan to have another CPA's assistance definitely. Thank you for your clarity. | |
| 5 July 2006 | |
| Hello,
I currently work for an employer at $58.00 per year w-2. I have an offer of $60.00 on a 1099 basis. I am wondering that if my comapny makes the $60.00 per hour and I paymeself a reasonable salary such as $30-$35 an hour. Will making this move make financial sense? I am also hoping to be able to take advantage of other advantages of having an s-corp. I know you are busy but I have that potential client awaiting my answer and I am unclear on the correct direction. Assistance is greatly appreciated. David | |
| 5 July 2006 | |
| If you can justify that 30-35 as reasonable, you'll be $4500 ahead on SS taxes, which you should invest in retirement since you're foregoing the SS taxes. That will create another $1000 deduction...now the cost of being a corp with added year end filing and quarterly work will run $1-2000 depending on how an accountant wants to handle your work. But you're clearly ahead of the game if that hourly rate is reasonable. | |
| 5 July 2006 | |
| I've always taken the position that "reasonable compensation" would be what an owner would pay to have comparable services performed by another person. I've also taken this without regard to the "intangible" quality that allows this specific owner to generate more revenues and profit than your averatge person.
For example, I have a ticket broker client that grosses $400K/year. He manages and operates the business, with 2 employees. We used a salary of $65K and distributions of $100K because $65K is what he paid himself per year before he incorporated, so he has history. In addition, for the duties that he performs as office manager, $65K would be a very reasonable salary. Again, never had an audit, but I would be comfortable making this argument to an IRS auditor. | |
| 6 July 2006 | |
| I was recently at a seminar where the instructor claimed he had a close acquaintance from the IRS who stated S-corp salary "reasonableness" is close to, if not the top, current priority for prospective examinations. He stated they aren't looking for those "slam-dunk" cases where no salary is taken and all distributions. Instead, they're looking for several big and small cases with "close calls". In other words, where salary and distributions might be closer, say 50/50. I don't think using 60/40 rules or any other "safe harbor" is appropriate. Instead, it seems "reasonableness" will first look to industry standards. If there's enough available cash and an owner is paying himself a "reasonable" salary in the eyes of the IRS, then the level of his distributions won't matter, low or exceedingly high. Even though so many clients can play the so-called "audit lottery", always remember that as tax practitioners there are certain regulations (professional standard - such as Circular 230) that do NOT allow you to sign a return if there's a certain percent chance (I don't remember the threshold) that a position won't stand against an audit. Just be careful - not only can your clients hurt themselves, they can hurt you. I don't want to sound paranoid, but caution is in order. | |
| 25 August 2006 | |
| this may sound like a dumb question, but why does it matter if they take a salary versus a distribution anyhow? the bottom line is that it all transfers over to their adjusted gross income on their 1040. so, the result would be the same tax liability. | |
| 25 August 2006 | |
| The Service wants some payroll taxes to pay my social security. | |
| August 25, 2006 | |
| It's all about SS taxes Chap. Only wages are subject to the 15.3% SS/FICA taxes. Income taxes are all the same, you're right. | |
| 25 August 2006 | |
| oh gotcha, thanks. i am not an accountant, but i do to credit analysis, which includes analyzing financial statements. also, if an s corp has two equal owners and assume that it is the first year in service. if one partner takes over 50% of his share of the equity of the company (including the current period earnings), would this be considered tax evasion (since he only paid taxes on 50% of the earnings but took a larger amount in distributions)? i would imagine his basis in the company would be brought to a negative and would think he would have to declare capital gains??? thanks in advance. | |
| August 25, 2006 | |
| Yeah, that's about right. (Sol: LOL at your edit, btw!!) The income that's taxed is the profit share. If he takes more than that, we've got schedules to keep on his basis and whether he took more than that, etc. and then have to deal with it accordingly. | |
| 25 August 2006 | |
| i was actually just browsing the net for a quick answer and found this site today, it is awesome!!! jr1 and sol, thanks for the fast feedback. since this topic kindof went dead, i hope its ok that i kindof took it in a new direction. but since we are on this, if the owner took greater than his share of equity in distributions, why not just take a loan from the company??? i mean, it makes sense. no cap gain taxes. | |
| August 25, 2006 | |
| Sure you're not an accountant? That's the trick, if you can call it a loan and keep it legit. Some more conservative accts never do that and always take it to income. I, rebel that I am maybe, have never taken one to income. But I am not beginning to document the heck out of these and consider whether I should or not.... | |
| 25 August 2006 | |
| jr, according to your post on the other topic, you still have to pay 15% cap gains on the note as well??? that is bogus imo, i never heard of paying taxes on loans, but i assume their ruling is that since it is a related party transaction, they partially weight it as a distribution and partially a loan; in the fact that the tax rate is lower than the 28% normal cap gain tax. | |
| August 25, 2006 | |
| Not on the loan unless it's not repaid. So if there's a note, and the loan's not repaid, or you figure it won't be and then decide to tax it, it's at the cap. gain rates. Without a note, the same thing is ordinary income. | |
| 25 August 2006 | |
| jr, i was not going to ask this, but it really is bugging the s#it out of me. here is a paraphrase from your quote on the other topic you are postin on:
"As to the second, the rules require that if there is a note document for the excess, it will be treated as cap gain, 15% plus state tax. If no note, ordinary income, 28+% plus state. Big diff." but on this thread you state that you don't have to pay the tax. just curious, thanks man. | |
| August 25, 2006 | |
| You sure have a lot of questions! That's ok...all I meant was that tax is due when you determine that that note won't be repaid, not when you create the note. I thought that maybe you'd misunderstood that along the way... | |
| 26 August 2006 | |
| Boy, is this confusing! Chaplowj, if you have equal shareholders in an S corporation, they should receive equal distributions. That's the simple answer. If one takes greater distributions than the other, you open up a number of potential issues. One is the possibility of having the S election revoked because it could be construed that you have two classes of stock, which is not allowed. I just wonder why one s/h deserves more, why not just pay him/her more in salary? JR1, what does this mean, "Some more conservative accts never do that and always take it to income." Take what to income? | |
| 26 August 2006 | |
| OK, let's get down to brass tacks -- have any of the many CPAs that have contributed to this discussion ever seen one of their S-Corps get audited and have reasonable compensation brought up by the agent if they actually *did* pay shareholders?
The reason that I ask, is that I've started an s-corp and will be paying myself an hourly rate, but I really want to minimize the rate for SS tax purposes. $23/hr is what I've originally come up with as enough to get by on while retaining the rest as profit (perhaps to be distributed in later tax years). | |
| 26 August 2006 | |
| When you think about the IRS fervor regarding salary vs. dividend, the hyprocrisy of it all is really troubling. If you have an S-Corp, they'll go after you for disguising salary as dividends, and if you have a C-Corp, they'll go after you for disguising dividends as salary. It's all pretty laughably stupid. | |
| 26 August 2006 | |
| Sure that's a ton of cash and all, but his business is actually illegitimate. This kind of thing made tech news a few months back, since to create an account for this type of online game you have to agree to terms and conditions, the most prominent of which is that you may not sell virtual currency for hard currency. It was smart for this chap to incorporate purely for liability reasons, forget that he's not saving any tax money since he's maxing out his SS wage base. If whoever runs this particular game decides to bring suit, it will be nice for him to at least be able to attempt to protect his personal assets behind the corp, though from what I've read, it's unlikely that the protection will really hold up considering the owner and only shareholder of the business was willfully violating a legal agreement for profit. | |
