S Corp Limitations on Bonus Frequency

By Heather Frances J.D.

The corporate structure offers liability protection for you and your shareholders, but it requires you to observe corporate formalities. Thus, you cannot use the business as a piggy bank, taking distributions or bonuses whenever you need extra personal cash. While there’s no hard-and-fast rule about how often your corporation can give bonuses, using bonuses as a significant method of providing compensation risks tax and liability consequences.

S Corporation Requirements

Like traditional corporations, called C corporations, S corporations offer liability protection for the owners, called shareholders. Under the corporate structure, shareholders are not personally liable for the business’s debts merely because they invested in the corporation. However, in an S corporation, corporate profits and losses flow through to each shareholder’s personal taxes. This avoids the double-taxation problem in which C corporations are taxed at the corporate level as well as the individual level. To take advantage of S corporation tax privileges, the corporation must qualify for this status in accordance with IRS regulations. For example, you cannot have more than 100 shareholders or more than one class of stock.

Shareholders as Employees

When your corporation’s shareholders perform services for the company, they are also considered employees and must be compensated as such. For example, if you are both a shareholder and the company’s president, you may receive distributions in the same way that other shareholders receive distributions. However, you must also receive compensation for services provided as president in the same way other employees receive compensation. Bonuses or corporate distributions cannot be used as substitutes for receiving a salary.

Ready to incorporate your business? Get Started Now

Deemed Compensation

Though it may be tempting to bypass payroll taxes by taking your compensation in some form other than a salary, doing so can create significant tax penalties. The IRS requires corporations to provide reasonable compensation to their employees in the form of wages that are subject to payroll taxes. If you receive a significant portion of your compensation from other sources, such as dividends, the IRS may deem these other sources wages and charge you payroll taxes anyway. The IRS considers each case on its own facts, so there is no bright-line rule about how much money you must take as your salary.

Piercing the Corporate Veil

In addition to tax consequences, taking too many bonuses and distributions might hurt your liability protection. Normally, the formal structure of the corporation provides a line between your personal liability and the corporation’s liability. However, when you blur the line between your personal and corporate affairs by taking frequent distributions or using the corporation as your personal source of funds, creditors might be able to convince a court that your corporate structure is a sham. Under such circumstances, the court can "pierce the corporate veil," breaking the protective barrier that shields your personal assets from corporate liability.

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

References

Related articles

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 closely held corporations — corporations where half of the shares are held by five or fewer shareholders — that are not publicly traded. However, the decision is affected by potential tax consequences.

How to Get an S-Corporation Enterprise

An S corporation is a corporation that has been approved by the IRS to be taxed under Subchapter S of the Internal Revenue Code. An S corporation is typically not taxed as an entity. Instead, the IRS and many state governments tax shareholders of an S corp on their proportionate shares of the corporation's taxable income. This results in a net tax savings in many cases. To form an S corporation, you must form a corporation that complies with Subchapter S restrictions, and then elect S corporation taxation with the IRS.

Advantages & Disadvantages of a C-Corp or S-Corp

The U.S. Tax Code and IRS recognize two different types of corporations: the C corporation and the S corporation. The two business types are taxed in two different ways. The C corporation pays taxes on its annual income and then its shareholders pay tax on any dividends they receive from the business. With an S corporation, the business does not pay any tax on its annual income. The shareholders are responsible for paying taxes on their share of the business’s annual income. As a result of this difference in how these organizations are taxed, C corporations and S corporations have different restrictions on several aspects of their business.

LLCs, Corporations, Patents, Attorney Help

Related articles

Can I Be Sued Personally if I Am an S Corporation?

Startup entrepreneurs can choose to organize their new businesses in several different ways. One popular form of ...

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 ...

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. ...

Difference Between Sole Proprietorship & Corporations in Taxes

If you’re debating whether to open a business under a corporation or as a sole proprietor, your decision can ...

Browse by category
Ready to Begin? GET STARTED