Tread carefully when determining compensation for S corp. shareholder-employees

Determining Compensation for S corp. Shareholder-Employees: By distributing profits in the form of dividends rather than salary. An S corporation and its owners can avoid payroll taxes on these amounts. Because of the additional 0.9% Medicare tax on wages in excess of $200,000 ($250,000 for joint filers and $125,000 for married filing separately). The potential tax savings may be even greater than it once would have been. (S corporation dividends paid to shareholder-employees generally won’t be subject to the 3.8% net investment income tax.)

But paying little or no salary to S corp. shareholder-employees is risky. The IRS has targeted S corporations, assessing unpaid payroll taxes, penalties and interest against companies whose owners’ salaries are unreasonably low. To avoid such a result, S corporations should establish and document reasonable salaries for each position. Done by using compensation surveys, company financial data and other evidence.

Do you have questions about compensating S corp. shareholder-employees? Contact us — we can help you determine the mix of salary and dividends that can keep tax liability as low as possible while standing up to IRS scrutiny.

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