Ref: IRC Subchapter S

Profitable S corporations MUST pay a reasonable W2 wage to it’s shareholder/officer(s). If this is not paid, this is a LARGE AUDIT FLAG. Many of these audits are now chosen through AI, comparing net income to the Officer Compensation reported on Line 7 of Form 1120-S. This is an easy test to perform.

Reasonable compensation takes into consideration the duties of the officer shareholder as well as the location of the business. There are many online salary surveys (e.g. Indeed) listing salary ranges by location and industry. These can serve as guidance.

IF AUDITED: The IRS will look at salary level and compare to reasonable surveys. If too low, the IRS will recharacterize some shareholder distributions as wages and assess FICA/Medicare taxes (currently at 15.3%) as well as FUTA tax on the shortfall. This amount may also be assessed interest and penalties.

COMMON PAYMASTER: If there are multiple S corporations commonly owned (e.g. three S corporations owned 100% by the same individual), then payroll can be paid by only one of them under the rules in IRC Sec 3121(s) and Section 3306(p). Also see Reg Secion 31-3121(s)-1. This treatment will save both in time devoted to multiple wage report preparation as well as overpayment (e.g. paying FUTA tax multiple times for the same employee).

If you have questions on the above, please contact us.