S Corporations – Critical Information Re: Shareholder Compensation


The IRS requires that all S Corporations must pay a salary to shareholder/employees(if profit supports it), or risk recharacterization of shareholder distributions and be subject to penalties.  We strongly recommend that all of our S-corporation clients pay a reasonable salary to all corporate shareholder/employees.  An employee/shareholder is defined as one who performed services on behalf of the corporation.  If you have a single shareholder corporation (or a single member LLC electing to be treated as an S corporation for tax purposes), and a business activity is being conducted within the company, you are a shareholder/employee, subject to the reasonable compensation rules.  Passive type investment holding companies would arguably not be subject to the rules, as no shareholder is providing services to the company, other than those nominally required to maintain the investment assets.

The IRS may recharacterize distributions as salary if a corporation fails to pay its shareholder/employees a reasonable salary through payroll.  This is an important distinction, since salary amounts are subject to payroll taxes and distributions are not subject to payroll taxes.  The IRS has indicated that it will step up enforcement in this area, beginning with S corporations who pay no salary at all to its employee/shareholders.

Contact us to assist you in setting a salary for shareholder/employees and in determining reasonable salary amounts to meet income tax and retirement objectives.

Automobile Expense

If you are utilizing your personal automobile for corporate purposes, you must reimburse yourself for use of your auto by the corporation, by taking a periodic reimbursement check from the corporation.  This reimbursement must be supported by adequate and written records to support the reimbursement.  Utilizing this method will permit you to deduct the automobile use by the corporation.  The IRS will be enforcing this provision strictly under audit.

Office Expense

You must reimburse yourself for use of your your home office expenses to take a corporate deduction. The IRS will be enforcing this provision strictly under audit.

© Daniel J. Chechele, P.A.