In our previous blog, we discussed the issues with paying no officer wages. Your S Corporation is properly paying officer wages. Is the amount reasonable? The IRS is hitting small businesses for paying unreasonably low officer wages.
Low Officer Wages Equals Tax Savings and IRS Audit
Many tax practitioners are assisting small businesses by set up S Corporations as a tax strategy for reducing self employment tax. The tax savings can be significant. However, the corporation must pay officers providing services reasonable compensation. The amount of wages paid to officers is essentially taxed for self employment. Therefore, officers have an incentive for reporting the lowest amount of wages possible. The IRS knows this and, therefore, auditing tax returns for reporting unreasonably low officer wages.
Reasonable Officer Wages
So what is reasonable compensation? IRS fact sheet FS-2008-25, Wage Compensation for S Corporation Officers, lists the following factors in determining reasonable compensation:
- Training and expertise
- Duties and responsibilities
- Time and effort devoted to the business
- Dividend history
- Payments to non-shareholder employees
- Timing and manner of paying bonuses to key people
- What comparable business pay for similar services
- Compensation agreements
- The use of a formula to determine compensation
Sources of information you can review to help determine reasonable officer wages are employment agencies, U.S. Department of Labor’s Bureau of Labor Statistics, and obtaining market analysis.
Tax Adjustments and Penalties Outweigh Tax Savings
The IRS has the authority to reclassify distributions, dividends, loan repayments, and payments to shareholders as officer wages. 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. Due to the increased pressure by the IRS in this area it is best to be conservative when determining the amount wages paid to officers of the S Corporation. The additional taxes and penalties that can be assessed due to a reclassification are too significant compared to the possible tax savings.
Call ALG Tax Solutions 855-MI-Tax-Help (855-648-2943) or provide your contact information online if you need assistance on this tax matter.
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.