Compensation for S Corporation Owners
regular C corporations, reasonable compensation"
can be a troublesome tax issue. The IRS
doesn't want shareholder executives to
inflate their deductible salaries while
minimizing the corporation's nondeductible
S corporation owners, the opposite is
true. If owner employees take what the
IRS considers "unreasonably low"
compensation, the IRS may recast the earnings
to reflect higher payroll taxes, along
with interest and penalties.
pocket to pick
"Eligible corporations that elecTS
status avoid corporate income taxes. Instead,
all income flows through to the shareholders'
personal tax returns.
1: Ivan Nelson owns a plumbing supply
firm structured as an S corporation. Ivan's
salary is $250,000 a year while the company's
profits are $400,000. The $650,000 total
is reported on Ivan's personal tax return.
2014, Ivan pays 12.4% as the employer
and employee shares of Social Security
tax on $117,000 of earnings. He also pays
2.9% Medicare tax on his $250,000 of salary.
As a result of recent tax legislation,
Ivan-who is not married-owes an additional
0.9% Medicare tax on $50,000, the amount
over the $200,000 earnings threshold (the
HctTreshold is $Zi}U,UUU orTajoint tax"
return). Altogether, Ivan pays well over
$20,000 in these payroll taxes.
Often, S corporation owners have a great
deal of leeway in determining their salary
and any bonus. Holding down these earnings
may reduce payroll taxes.
2: Jenny Maxwell owns an electrical
supply firm across the street from Ivan's
business. Jenny's company also is an S
corporation. She reports the same $650,000
of income from the business but Jenny
classes only $75,000 as salary and $575,000
as profits from the business. Thus, she
pays thousands of dollars less than Ivan
pays for Social Security and Medicare
As mentioned, the IRS might target S corporation
owners suspected of lowballing earned
income. Therefore, all S corporation shareholders
should take steps to justify the reasonableness
of their compensation.
you own an S corporation, consider spelling
out your salary level in your corporate
minutes. Where possible, give examples
and quote industry statistics that show
your compensation is in line with the
amounts paid to executives at similar
explanations also might help. Depending
on the situation, you might say that business
is slow, in the current economy, so the
minutes will report that you are keeping
your salary low to provide working capital
for the company. If your business is young,
the minutes could explain that you're
holding fixed costs down, so the company
can grow, but you expect to earn more
in the future. In still another scenario,
you might say that you are nearing retirement
and making an effort to rely more on valued
employees, so a modest level of earnings
reflects the actual work you're now contributing.
illustrated above, holding down S corporation
compensation can result in sizable payroll
tax savings. Our office can help you establish
a reasonable, tax-efficient plan for your
salary and bonus.
Beyond compensation, health insurance
also may affect the payroll tax paid by
an S corporation owner. Special rules
apply to anyone owning more than 2% of
the company's stock.
the company has a health plan and pays
some or all of the costs for coverage
of such a so-called "2% shareholder,"
the payments will be reported to the IRS
as taxable income. However, that amount
will not be subject to payroll taxes,
including those for Medicare and Social
Security. The company can take a deduction
for these payments, effectively reducing
corporate profits passed through as taxable
income for the shareholder.
addition, the S corporation shareholder
may be able to deduct the premiums paid
by the company-this deduction can be taken
on page 1 of his or her personal tax return,
which may provide other tax benefits.
However, such an "above -the-line"
deduction cannot be taken in any month
when the shareholder or spouse is eligible
to participate in another employer-sponsored
health plan. Also, this deduction can't
exceed the amount of the shareholder's
earned income for the year.
can be a complicated issue, especially
if your state law prevents a corporation
from buying group health insurance for
a single employee. If you own an S corporation,
our office can help you decide the best
way to hold down payroll tax as well as
income tax from your health plan.
Source: August 2014 AICPA Client Bulletin