One reason small business owners like the S corporation tax structure is because profits generally aren’t taxed at the corporate level. They “pass through” and are taxed only once to the individual shareholders. S corporation shareholders also can take money out of the company free of federal employment and self-employment taxes. But only up to a point.
Put Yourself on the Payroll
It can be tempting for S corporation owner/employees to underpay themselves to keep employment taxes low and then supplement their income with distributions or other payments that aren’t subject to employment taxes.
But the IRS is on the lookout for owners reporting low or no income. So if you’re an owner/employee, make sure your compensation is “reasonable” for the services you provide. If it isn’t, the IRS may reclassify your “other” compensation as salary and assess a stiff penalty (100% of the unpaid taxes) for failure to remit payroll taxes.
Comparable Is Key
There is no set definition of reasonable compensation. However, you can be reasonably certain that such factors as your duties and responsibilities, how much time and effort you put into your business, and how much training and experience you’ve had should be included when determining your compensation. To get an idea of how much similar businesses are paying for comparable services, you can go to www.bls.gov, a website with salary information hosted by the U.S. Bureau of Labor Statistics.
The topic of S corporation compensation has become an IRS audit issue. Avoid problems by paying yourself a reasonable salary.
For more help with individual or business taxes, connect with us today. Our team can help you with all your tax issues, large and small.