One of the benefits of forming an S-corporation is that rather than being subject to employment (FICA) taxes on all of your business’s earnings, you are only subject to employment taxes on the salary you pay yourself. You may think to yourself, “Well, great! I will form an S-corporation and pay myself a salary of $0, and save 15.3% on 100% of my profits!” As they say, if something sounds too good to be true….
There are two major factors in regard to wages that the IRS considers when auditing an S-corporation return. First, they look to see if there is “compensation of officers” listed on Line 7 of Form 1120S, the annual income tax return required to be filed by an S-corporation. This is where your wages as an owner of the business would be listed. One of their BIG RED FLAGS to pull a return for an audit is when Line 7 lists no wages paid to officers. The IRS’s stance is that no one works for free, and if you are providing services to the company, you must be compensated for your time.
Then you may think, “Fine then, I will pay myself minimum wage, about $15,000 a year, and then I can shelter the remaining $185,000 of my $200,000 profit from employment taxes!” Again, not so fast. After the IRS determines that you have paid yourself a salary, they next determine whether that salary is reasonable. How does the IRS determine whether a salary is reasonable? Well, as most things IRS related, that answer is grey (you may notice I say this a lot – that’s because it’s so frustratingly true!). The IRS states here: “wages paid to you as an officer of a corporation should generally be commensurate with your duties.” That definition is clearly a statement that can be left up to quite a bit of interpretation. What is my recommendation? Check out Salary.com. Are you a high level direct sales consultant? Maybe check out what sales directors in your zip code make. If you can substantiate the income you choose for yourself with sound reasoning, you have a much stronger leg to stand on!
Are you starting a business and trying to determine how to pay yourself? I can help! Shoot me a message via my contact form and we can talk!