april2022 - 26

FEATURE
S Corp Salary Guidelines
What is Reasonable Compensation? By Nellie Akalp
CAN YOU HELP your S Corp clients determine a reasonable
compensation? Here's what your clients need to
know to stay on the Internal Revenue Service's (IRS) good
side.
WHAT IS AN S CORP?
S Corps are corporations opting to
flow their business income, losses,
deductions, and credits through
to their shareholders for federal
tax purposes. S Corp shareholders
then report the income and losses
on their personal tax returns and are
taxed at their individual income tax
rates. One reason LLC and C-Corp
owners elect the S Corp structure to
avoid double taxation on the corporate
income. March 15 (two months
and 15 days after the year-end) is the
deadline to elect S Corp status.
A corporation must meet the
following requirements to qualify
for S Corp status:
* Be a domestic corporation
* Have only allowable shareholders:
These may be individuals, certain
trusts, and estates and cannot be
partnerships, corporations, or nonresident
alien shareholders
* Have no more than 100 shareholders
* Have only one class of stock
An S Corp isn't a legal business
entity in and of itself. Rather, the S
Corp designation is a special election
made by an LLC or C-Corp with
the IRS that allows the business to
offer the same liability protection as
corporations and LLCs, protecting
the owners' personal assets against
debts and lawsuits of the company.
THE S CORP ADVANTAGE
Besides liability protection and
avoiding double taxation, S Corps
have some other advantages:
* They are only required to file an
income tax return once a year
* They can sell shares of stock, and
* They have perpetual existence,
meaning the business continues to
exist even if the owner leaves or dies.
The S Corp is also a popular
entity election because it allows
the owner(s)
to divide business
income into salaries and distributions.
Owners pay payroll taxes
on wages only, not on shareholder
distributions. Dividends are the
distributions from the business's
income as a return of capital to a
shareholder and are not subject to
payroll taxes. For that reason, the
IRS keeps a close eye on an S Corp's
dividend distributions to ensure the
corporation is not merely trying to
avoid paying employment taxes.
WHAT IS REASONABLE
COMPENSATION?
It can get messy if the IRS believes
owners are trying to hide wages
behind distributions to avoid paying
payroll taxes. S Corp owners must
pay " reasonable
compensation "
to each shareholder/employee in
exchange for any services provided
by
the
shareholder-employee.
Defined by the IRS, " reasonable
compensation is the value that
would ordinarily be paid for like
services by like enterprises under
like circumstances. " In general, if
a shareholder does anything more
than contribute money to the business,
the shareholder is considered
an employee. If this is the case, the
shareholder must be paid wages
26 APRIL 2022 ■ www.CPAPracticeAdvisor.com
comparable to similar services
compensated for similar industries.
The definition of an employee
for payroll taxes purposes-FICA,
FUTA, SUTA and income tax withholding-includes
corporate officers
and shareholders, if and when any
services are performed for the
business. Courts have consistently
held that S Corp owners/officers/
shareholders who work and provide
anything more than minimal services
to the company are required
to receive wages-wages that are
subject to federal employment taxes.
Although the definition of what
constitutes a " reasonable " wage may
seem subjective, the IRS scrutinizes
the S Corp's source of income-its
gross receipts-and then determines
if (and what tasks) the owner/
shareholder performed for the S
Corp to assist in generating the
gross receipts.
Any portion of gross receipts
generated by either the shareholder's
involvement or in the act of assisting
employees in performing services
must be compensated as wages and
subject to employment taxes. The
IRS recommends considering the
following factors when determining
the reasonableness of pay:
* The duties performed by
the employee
* The volume of business handled
* The character and amount of
responsibility
* The complexities of your business
* The amount of time required
* The cost of living in the locality
* The ability and achievements of
the individual employee performing
the service
* The pay compared with the gross and
net income of the business, as well as
with distributions to shareholders if
the company is a corporation
* Your policy regarding wages for
all employees
* The history of salaries for
each employee
The U.S. Bureau of Labor Statistics
compiles comprehensive
wage data searchable by occupation
nationwide, in addition
to comparable wages by state,
region, and city.
FILING FOR S CORP STATUS
To be treated as an S Corp, a corporation
or LLC must complete and
file IRS Form 2553 no more than two
months and 15 days after the beginning
of the tax year. S Corp status
will begin the next calendar year if
your business misses the deadline.
An S Corp must file its annual
tax return by the 15th day of the
third month following the end of
the tax year, which means March
15 (unless the 15th falls on a
weekend or holiday). All financial
activity must be filed on Form 1120S,
along with a Schedule K-1 for each
shareholder. Be sure clients prepare
and save detailed documentation
for each shareholder to support
any wages vs. dividends concerns.
Documentation should describe the
type of work and number of hours
completed by the shareholder,
with comparable salaries in like
positions as proof of reasonable
compensation. ■
Nellie Akalp is a entrepreneur, business
expert, and mother. She is the CEO of
CorpNet.com, a resource and service
provider for business incorporation, LLC
filings, and corporate compliance services
in all 50 states. Akalp and her team
recently launched a partner program for
accountants to help them streamline the
business incorporation and compliance
process for their clients.
http://www.CorpNet.com http://www.CPAPracticeAdvisor.com
april2022

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