How To Determine Your Pay In An S Corporation

Mon, 02/13/2012 - 1:58pm

As addressed in my last post, profits of an S Corporation is not considered self-employed, meaning that the profits are not treated as self-employment income. Owners of S Corporations are required to pay themselves a reasonable salary like every other employee. Reasonable can be a subjective concept. If the government does not agree with your concept of reasonable, the IRS may come back years later to audit your files to collect unpaid fees and payroll taxes (plus some hefty penalties).

What is a reasonable wage? The IRS considers a multitude of factors, including your role in the business, how much experience you bring to the table, how much time and effort you have invested in the enterprise and other non-scientific aspects. Another key indicator of the reasonable wage question is the amount of distributions (cash) you take out of the company. For example, if your business is not profitable and you do not take a distribution, it is very likely you’ll be able to get away with not paying yourself a wage (and the associated payroll taxes.) If your company shows a profit, you’d be well advised to pay yourself and deduct the appropriate amount of taxes.

Another issue to consider is medical insurance. If you own more than two percent of your S Corporation, the medical insurance your company pays on your behalf should be considered part of the compensation to its officer. The benefit should be included in your gross wages listed on your W-2, but not subject to Social Security and Medicare. Your personal tax return would then need to report this amount both as W-2 wages and as an “above the line” deduction of self-employed health insurance.

If you are looking for some additional resources, here are a couple of articles you may want to read:

From the IRS website: http://www.irs.gov/newsroom/article/0,,id=200293,00.html
From searching the topic on Google and Bing: http://www.thinkinglike.com/S-Corporations-Reasonable-Salary.html

The start of the new year may be the best time to think about giving yourself a raise and begin to pay yourself that reasonable wage we discussed earlier. If you’re already an S Corporation, talk with your tax professional to be sure payroll taxes are in your budget. Those taxes need to be paid no later than January 31^st.

The content of this blog should not be used for actual tax advice and may not be appropriate for all situations. For more information, or a free financial analysis of your small business, call Brett Backues, CPA, atMyCFOLink at 425-747-5355 or log onto http://mycfolink.com.