Many businesses elect the S-Corporation status in order to avoid double taxation on corporate income and losses, which actually then “flow-through” to the shareholders’ personal tax returns and are assessed at individual income tax rates. However, an S-Corporation can find itself at an automatic risk of getting audited if there is no stated amount for “Compensation of Officers” on Line 7 of Form 1120S.
The IRS assumes that no one works for free. Therefore, zero salary as well as salary below minimum wage are unreasonable. Whether you consider yourself an officer or shareholder who performs more than minor services to the S-Corporation, you are still an employee entitled to wage compensation (subject to federal employment tax). S-Corporation owner-employees must pay themselves a salary and pay payroll taxes on that salary, regardless if the business is losing money. Otherwise, they will be assessed a payroll tax penalty of 100% of the taxes owed.
Though there are no specific guidelines in the Code or the Regulations, a reasonable and appropriate level of a corporate officer’s salary can be evaluated upon a number of factors including: responsibilities, experience, number of hours worked, comparable market rates, and payments to non-shareholder employees.
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