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

By Heather Frances J.D.

One of the first decisions you must make when establishing your business is what structure your business will take. Business structures, such as corporations, partnerships and limited liability companies, are governed by state laws; however, federal tax law determines whether your corporation is eligible for special tax status as as an S corporation. Shareholders in S corporations include the corporation's profits and losses on their personal income taxes rather than the corporation; thereby, avoiding the so-called "double taxation." Federal law also determines the types of compensation available to S corporation shareholders and officers.

Shareholders as Employees

Shareholders can be uninvolved investors, but S corporations often have shareholders who are also officers of the company. For example, a family-owned construction business that includes the father, mother and son as shareholders might also have the father as president, mother as secretary/treasurer and son as vice president. When shareholders act as officers, they must receive compensation for their services as employees of the corporation in the same way they would receive compensation if they were not shareholders. However, officers who do not perform any services or perform only minor services are not necessarily entitled to compensation or considered employees of the corporation.

Amount of Compensation

You must provide reasonable compensation for your S corporation’s employees. The amount of compensation that is “reasonable” depends on such factors as the employee’s duties and responsibilities, training and experience, and what comparable businesses pay for similar services. There are no specific guidelines for determining reasonable compensation, so courts consider the facts and circumstances of each case independently. Compensation must first be made in the form of wages before non-wage distributions may be given to employee-shareholders. In other words, if you give money to someone as compensation for services he provides to the corporation, the compensation is considered wages.

File a DBA for your business online. Get Started Now

Health Insurance as Wages

Your S corporation can provide a portion of your officers’ compensation in the form of payment of health insurance premiums. As long as the employee-shareholder owns more than 2 percent of your corporation’s stock, health insurance benefits are not subject to Social Security, Medicare or unemployment taxes, though they must be noted on the employee’s W-2 form. Depending on the employee’s health insurance situation, your corporation’s payment of his insurance premiums may provide a significant source of untaxed compensation.

Employment Taxes

Shareholders who are also employees of the corporation must pay employment taxes even when compensation is paid in a form other than wages, such as through distributions or dividends. If you don't pay compensation as wages but erroneously as something else, the IRS can deem that compensation to be wages after the fact and charge employment taxes on the amount that should have been considered wages. In one Tax Court case, the court held that the sole director and shareholder of a veterinary clinic was an employee of the clinic even though he took his compensation as distributions of the corporation’s net income rather than as wages. As an employee, his distributions were subject to federal employment taxes.

File a DBA for your business online. Get Started Now
An S Corporation's Board of Directors' Compensation Vs. a Shareholder Distribution

References

Related articles

How Are Property Distributions From an S Corp Taxed?

S corporations are flow-through entities, so business income and losses are taxed at the shareholder level; the business pays no income tax. As a result, the taxes applied to property distributions are limited because the shareholder already paid taxes on the property when it was earned in prior years. What taxes a shareholder might be required to pay depends on the reasons he received the distribution, how much he has paid in taxes in prior years, and how many distributions he received from the S corporation in the past.

What Forms Do I Need to File for an S Corp?

An incorporated business is automatically designated by the Internal Revenue Service as a C corporation for income tax purposes. However, certain smaller corporations can elect to be taxed as S corporations without forfeiting the liability protections that the corporate structure affords to shareholders. Making the initial election requires filing an IRS form. Once S corporation status is granted, the tax forms the corporation must file annually will change.

What Liability Does a Corporation Have for Its Officers?

Employees of a corporation, which includes its officers, generally aren’t personally liable when engaging in business transactions or otherwise acting as a representative of the business. Instead, the corporation is solely liable for the acts of its officers. However, exceptions do exist when a corporation’s officers act outside the scope of their duties.

Related articles

Can Non Profit Organizations Have Paid Employees?

State laws impose tight restrictions against nonprofit corporations' distributing profits to shareholders. Despite ...

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 ...

S Corp Limitations on Bonus Frequency

The corporate structure offers liability protection for you and your shareholders, but it requires you to observe ...

C Corp Salary Rules

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

Browse by category
Ready to Begin? GET STARTED