S Corporations are ever popular as a tax vehicle for businesses to minimize paying Social Security and Medicare tax as well as avoid the possibility of double taxation with a C Corporation.
S Corporations however, MUST pay “reasonable compensation” to a shareholder-employee in return for services. This is required by IRS law and is an easy and favorite audit for the IRS. Please make sure that you understand how this “reasonable compensation” applies in your business. A shareholder that performs no services or only minor services to the corporation is not comsidered an employee and is exempt from the “reaosnable compensation” requirement.
Reasonable compensation – a broad definition. How aggressive do you want to be? What is your risk tolerance? This is where working with a tax advisor is so critical. An experienced tax professional can guide you as to your specific situation. In my opinion, no compensation is not reasonable. So what does the IRS look at in determining this “reasonable compensation”? Well, first stop is an internet search for comparable salary information. Then they look at the shareholder’s training and experience, duties and responsibilities, time and effort devoted to the business. The IRS will also look at amounts paid to family members.
There are so many active IRS court cases on the subject of misclassified wages for S Corporation shareholders that I highly recommend you get advice from your tax advisor to determine the most strategic compensation for you and your business.
Fo the differences between entity types, go to our RESOURCES page on our website.