Generally when an S Corporation has a shareholder/employee who owns at least two percent of the stock of the S Corporation, the S Corporation is required to pay that employee (and related parties) a reasonable salary. A reasonable salary is based on the facts and circumstances of the company, such as the number and types of services provided by this employee (such as personal services), services provided by other employees, how active the employee is, the number of hours worked, how other employees are compensated, and the profitability of the company to name just a few considerations.
There is one situation where the company is not required to W2 compensate this type of employee. If the shareholder/employee receives no distributions during the year, then no salary needs to be paid to that individual. If distributions are made, then a salary needs to be paid. There are numerous court cases that state that the first money paid out of the corporation to the shareholder/employee is salary (to the extent of reasonable salary). In a recent court case (TC Memo 2016-161), the S Corporation had no profits, paid no salary, but repaid shareholder loans. The IRS tried to reclassify those payments as salary. The Tax Court disagreed, stating that no salary was required since no distributions were made.
If you want to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, including how to adopt an age-weighted profit-sharing plan, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
