Can You Have a Corporation Without Paying Salaries?

By Terry Masters

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.

Legal Authority

The incorporation statute of the state where the corporation has filed its articles of incorporation governs it activities. That law establishes the corporation as a separate entity with many of the rights of an individual and grants it authority to act in its own name. One of the powers the law gives corporations is the ability to hire people. The exercise of this authority is discretionary and not mandatory, however. A corporation has the legal right to employ hundreds of people or none at all.

Perpetual Existence

A corporation comes into existence when it files articles of incorporation with the state. The viability of that document is the only barometer of the existence of a corporation. If a business presents itself in every way like a corporation but has not filed articles with a state, it cannot be treated as a corporation under the law. Likewise, if a business with filed articles of incorporation does nothing to further its business activities, it would still exist as an entity until someone files articles of dissolution and effectively withdraws the incorporation paperwork from the state.

Ready to incorporate your business? Get Started Now

Ownership Withdrawals

When a corporation is in startup phase, it is common for the owners to work for the corporation until the business can afford to hire employees. Nothing requires the owners to draw a salary from the corporation. The owners are within their rights to work for their business for free. Sometimes, however, owners work for the company and take withdrawals as profits, also known as dividends, to avoid paying payroll taxes on the money. These dividends are sometimes distributed periodically, such as every quarter, or once a year. Technically, this practice is perfectly legitimate from a legal standpoint. It often runs afoul of the IRS, unfortunately.

The 60/40 Rule

The IRS wants to make sure it collects payroll taxes on income. If people are allowed to classify infusions of cash as dividends or some other category of payment, the payroll taxes that support the economy, such as Social Security taxes, will diminish. Although a corporation can operate without paying a salary, if it is making money and distributing profits, the IRS figures someone must be doing the work and classifies that person as an employee. The IRS has held that if a corporation is distributing profits to owners and the owners are the only ones working for the company, 60 percent of the distribution should be treated as salary and only 40 percent as dividends. Owners are free to disregard this rule of thumb but other distribution plans can expose the corporation to heightened IRS scrutiny.

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

References

Resources

Related articles

Corporation vs. Officer vs. Owner

A business that operates as a corporation generally drafts bylaws – a document that governs all aspects of the company. Commonly, the bylaws will provide the limitations on the type of transactions the corporation can engage in, the rights of owners, the role of the board of directors and how the business will be managed by officers.

Can the Officer of a Corporation Be Held Personally Liable?

One of the most significant benefits to organizing a business as a corporation is that it protects the officers and shareholders from personal responsibility for their actions on behalf of the corporation. Ordinarily, an officer cannot be held personally liable, as long as he is acts within the scope of his authority and within the bounds of the law. The only exception to this protection is if a case can be made that the corporate entity is merely a shell that the owners are using to defraud the public.

Tax Consequences of Converting a C-Corp to an S-Corp

Corporations are business entities formed under state law that exist separately from their owners. An S corporation is simply a C corporation that has elected to be taxed as a pass through entity. Converting from a C-corp to an S-corp has significant tax implications, which include potentially lowering the overall tax burden on the shareholders, but also changing who reports the income each year and limiting when the income can be reported on the shareholder's tax returns. However, an S-corp must meet several criteria, including having less than 100 owners, only having U.S. resident or U.S. citizen individuals and certain entities as shareholders, and not having more than one class of stock.

LLCs, Corporations, Patents, Attorney Help Incorporation

Related articles

C Corp Salary Rules

A C corporation is a type of business organization that is a separate legal entity from its owners, or shareholders. ...

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 ...

What Is the Difference Between an Unincorporated Association & a Corporation?

In choosing between a corporation and an unincorporated association, the main concerns are filing requirements, ...

Can a Nonprofit Board Fire the Executive Director?

A nonprofit's success is often tied to the zeal of its primary representative: the executive director. The ED is ...

Browse by category
Ready to Begin? GET STARTED