C Corp Salary Rules

By John Cromwell

A C corporation is a type of business organization that is a separate legal entity from its owners, or shareholders. This means that the shareholders are not personally responsible for the business’s liabilities, but the corporation must take steps to meet certain responsibilities. One of those responsibilities is paying its employees. The rules for paying salaried workers of a corporation may vary based on whether the employee is a shareholder of the corporation and whether the salary is considered "excessive."

A C corporation is a type of business organization that is a separate legal entity from its owners, or shareholders. This means that the shareholders are not personally responsible for the business’s liabilities, but the corporation must take steps to meet certain responsibilities. One of those responsibilities is paying its employees. The rules for paying salaried workers of a corporation may vary based on whether the employee is a shareholder of the corporation and whether the salary is considered "excessive."

Fair Labor Standards Act and Salaried Employees

The Fair Labor Standards Act (FLSA) is a federal law that dictates how employees are paid in relation to wages and overtime. All employers must comply with these rules in paying their employees unless the job in question is “exempt.” Among the exempt jobs are certain types of salaried positions. To qualify for the exemption, the job must require that an employee be paid a certain, guaranteed amount of money every week she performs any work. The work must be of a certain type, such as managing a part of the business; participating in a “learned profession" such as being a doctor; or performing nonmanual work that supports management by the employee exercising independent judgment on matters significant to the business. The job must also pay at least $23,600 per year. If the job qualifies, the corporation does not have to comply with the FLSA with regard to those employees.

Ready to incorporate your business? Get Started Now

Shareholder-Employees

Some shareholders of the company may also be employed by the corporation. This is common practice, especially as some corporations pay their employees by issuing them stock. In other types of business organizations, such as sole proprietorships, the owner has to pay “self-employment” tax on what he receives from the business. Since a corporation is an independent legal entity, the shareholder-employees do not have to pay self-employment tax. Instead, the employees must pay half the employment taxes while the corporation pays the other half.

Tax Deductibility

Since a corporation pays taxes, an important consideration is what it can deduct from its gross income for tax purposes. A corporation can deduct the wages and salaries it pays its workers. However, the IRS will only permit the corporation to deduct “reasonable” wages"; if the corporation pays its employees, but especially its management, an unreasonably lavish salary, the IRS will not permit all of it to be deducted. There is no definitive test to determine what constitutes a reasonable salary, but generally the IRS and a reviewing court will consider what other people with similar jobs earn as well as the employee's performance.

Salary vs. Dividend Income

If the income is excessive, and the recipient of the salary is an employee-shareholder, the IRS can relabel the “excessive” portion of the salary as a dividend distribution. While the excessive portion of the salary can no longer be deducted, the recipient generally does not have to pay his standard income tax rate on that portion. Instead, he can pay the lower capital tax rate on that amount.

Ready to incorporate your business? Get Started Now
Can Non Profit Organizations Have Paid Employees?

References

Resources

Related articles

The Liability of an S Corporation

It is important for any corporate shareholder to understand what liability he may be exposed to by owning a portion of an S Corporation. S Corporations are regular corporations that qualify for a special tax status with the IRS. While an S Corporation is taxed as a partnership, it has the same liability issues as a normal corporation. A discussion about liability of a corporation could be about one of two things. The first concerns the liability of the S corporation’s shareholders for the actions and financial obligations of the business. The second regards the liability of the S Corporation for the work done on its behalf.

Can an Owner Be a Manager in a C Corporation?

A C Corporation is an independent, state registered legal entity used to organize businesses. It is also an organization that has a very formal and regimented control structure. The shareholders own the business, but they do not necessarily control the day-to-day operations of the business. Instead, the corporation’s operations are directly controlled by managers and officers. A shareholder can hold a managerial position in her company, but the process of obtaining that position may be more complicated than if she had applied for the job as a non-shareholder.

Can You Have a Corporation Without Paying Salaries?

Once an owner forms a corporation, there is no law that requires it to hire employees or pay salaries. Legally, the corporation exists as long as articles of incorporation are on file with a state and the company remains in good standing by filing any required reports or information updates with the state business registrar. If the company is conducting business, however, it is the opinion of the Internal Revenue Service that someone must be acting on the corporation's behalf. In that case, any money the person receives from the corporation will likely be classified as salary, whether or not the owners intended the distribution to be viewed that way.

LLCs, Corporations, Patents, Attorney Help

Related articles

An S Corporation's Board of Directors' Compensation Vs. a Shareholder Distribution

An S corporation is a "pass through" entity, and is taxed under the IRS code, Subchapter S. The corporation does not ...

How Much Should I Pay Myself From My Corporation?

An owner's decision regarding how much salary to take from a business is generally a private management decision for ...

Do You Have to Pay Officer's Salaries Out of S Corporations?

One of the first decisions you must make when establishing your business is what structure your business will take. ...

LLC & Employees' Salaries

Limited liability companies are free to operate the business with as many or as few employees as necessary. Some LLCs ...

Browse by category
Ready to Begin? GET STARTED