Many owners of S Companies take low salaries so that the bulk of the profits are passed to their personal returns free of Social Security and Medicare taxes. Both the IRS and the courts are consistently ruling against such arrangements.
In a recent case, a CPA set up an S Corp and set his salary at $24,000. The remaining $203,000 was reported as profits on his personal tax return. An Appeals Court agreed with the IRS that the pay was unreasonably low, relying on an expert’s testimony that the CPA’s service were worth $91,000. The tax court held that the $67,000 of the profits was properly reclassified as salary.
Determining what is a reasonable salary is the key. In this case, the reason the CPA’s services were valued at less than half of his profits was that employees performed significant services.
Check with your tax advisor now if you have an S Corp where you are taking little or no salary.
Like any good CPA, I need to add a disclaimer: Unfortunately, it is impossible to offer comprehensive tax info over the internet, no matter how well researched or written. And remember, I love my readers but having me bookmarked on your computer doesn’t make you a client: before relying on any information given on this site, contact a tax professional to discuss your particular situation.