As the owner of an S corporation, it is important that you take a reasonable salary for the work that you do. A big concern of the IRS is the issue of whether or not an S corporation pays reasonable compensation to its shareholders. Often, shareholders avoid paying a salary to avoid paying employment taxes. Instead, they take money out of the corporation as dividends. Filing an S corporation return that reports income but no salary is a red flag for the IRS and can trigger an audit.
Often, in these cases, the IRS recharacterizes a portion of the S corporation’s net income as wages. Courts have held that an officer of an S corporation who performs substantial services for the corporation and who receives remuneration in any form for those services is considered an employee, whose wages are subject to federal employment taxes. An S corporation cannot avoid federal employment taxes by characterizing compensation paid to its shareholders as distributions of the corporation’s net income, rather than wages. In such cases, the S shareholders must be treated as an employees and the distributions will be recharacterized as wages.
In order to head off an IRS audit, it is important for us to determine what would be a fair salary for you to take from the corporation. By appropriately documenting the amount we arrive at, we can defend against any attempted increase in compensation by the IRS should you ever be audited.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
74478 Highway 111 #3
Palm Desert, CA 92260
Toll Free: (877)CPA-Help or (877)272-4357
P.S. My firm is based upon referrals. Please feel free to refer my firm to anyone you know that is looking for a new CPA and/or tax preparer. Thank you in advance.