S Corp Owners Must Take a Salary

Small business tax expert Jean Murray recently posted important reminders for owners of S Corporations based on the results of two recent tax court cases where the IRS ruled on S Corp owners not taking salaries. In one case, the owner reported a net income for himself as president, but didn’t issue a W-2 or report income from his S Corp. In another case, the owner, the only full-time employee, stopped taking a salary during a tough year and transferred personal funds, without any documentation, to the company to cover expenses.

Murray reports the following important reminders:

  • S Corporation owners who work in the business are employees. The IRS expects that owner/employees to take a salary, and it must be “reasonable,” based on the typical salary for that type of position.
  • Amounts paid to owner/employees are subject to all payroll taxes and are subject to all payroll taxes and tax reports.
  • If a business owner loans money to a business, there should be documentation of that loan; it must be an “arms length” transaction, as if the owner and the business were not related. Even if the business repays the owner for a loan, that owner must still receive a reasonable salary.

I’m often asked how one determines a reasonable salary. I point to IRS fact sheet FS-2008-25, Wage Compensation for S Corporation Officers, that lists the following factors in determining reasonable compensation: training and experience, duties and responsibilities, time and effort devoted to the business, dividend history, payments to non-shareholder employees, timing and manner of paying bonuses to key people, what comparable businesses pay for similar services, compensation agreements, and the use of a formula to determine compensation.

The U.S. Department of Labor’s Bureau of Labor Statistics, local employment agencies, and your own market research can all provide data on comparable compensation.

Leave a Reply

Your email address will not be published. Required fields are marked *