An S Corporation is a popular entity structure for small businesses. Many tax practitioners help small business set up S Corporations to reduce self-employment tax. This strategy can back fire if the corporation reports unreasonably low or no compensation to the officers/owners. This is an audit risk as the IRS is cracking down on business for not reporting officer wages.
No Self-Employment Tax on S Corporation Income
One of the benefits of an S Corporation is that a shareholder’s share of income from the business is not subject to self-employment tax. The tax savings can be up to 15.3% compared to a Doing Business As (DBA) business or single member LLC treated as a disregarded entity. However an officer that provides services to the corporation must receive compensation for the services provided. Generally, most small businesses set up as a corporation should be reporting officer wages.
Audit Me Please
Compensation to S Corporation officers is a highly contested area by the IRS and a major audit risk. The IRS knows that many practitioners are setting up S Corporations for their clients as a tax strategy to reduce self employment tax. If you review your Form 1120S, U.S. Income Tax Return for an S Corporation, and the line “Compensation of officers” is left blank, then you are asking for an audit. The IRS has the authority to reclassify distributions, dividends, loan repayments, and payments to shareholders as officer wages. The cost to the business if the IRS reclassifies payments to officers as wages is significant. The company will be responsible for paying the back self-employment tax and the additional tax assessed will be heavily penalized for not filing and paying payroll tax returns.
Check your S Corporation return
At the very least, your S Corporation should be paying you wages. The amount paid must be reported on the “Compensation of officers” line of the corporation tax return. If you are properly paying officer wages, I recommend you review your past corporation tax returns to insure that your tax preparer is properly reporting officer wages on the corporation tax returns.
In a follow up blog, we will review what the IRS defines as reasonable compensation to corporation officers.
If you need help due to a tax audit on S corporation officer wages, we can assist you further, call ALG Tax Solutions 855-MI-Tax-Help (855-648-2943) or provide your contact information online.
IRS Circular 230 Disclosure: To the extent this writing contains advice on a federal tax issue, the advice is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed in this communication.