S Corporations present myriad benefits to the small business owner. One of the potential benefits is reduced federal employment taxes. S Corp owners and employees can reduce employment taxes by paying themselves low salaries, thus less employment taxes on those salaries. The S Corp owner compensates for the lower salary by paying himself or herself with money that is not subject to employment taxes, such as cash distributions and dividends from earnings. BEWARE: the IRS is on patrol for S Corp owners who engage in this practice.
Recent decisions by the U.S. Tax Court have eroded the S Corp owners' ability to avoid employment taxes to the extent he or she may have enjoyed in past years. For instance, a business owner who failed to report wages on his tax return was imputed with wages of over $83,000 for the year by the IRS. The owner then owed employment taxes and penalties on that amount. The takeaway: if you perform services for your S Corporation but you do not pay yourself a reasonable salary for your services, the IRS may be able to argue that your distributions, dividends, or loans you've received from the company are wages. Thus, be reasonable, pay yourself a salary and don't try to fly under the tax radar.
If you have questions on the proper business entity for you and your business, call the office today to discuss or set up an appointment.
*The foregoing is not meant as tax advice. Please consult a tax professional to discuss your personal situation.