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


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 business organization is incorporation and filing taxes under Subchapter S of the Internal Revenue Code, which offers the limited liability advantages of a corporation but the pass-through taxation of a sole proprietorship. While this is a common corporate form for small and medium-sized businesses, the limited liability offered by corporate status is not absolute. You can still be sued personally, even if you operate as an S corporation.

Can Non Profit Organizations Have Paid Employees?

State laws impose tight restrictions against nonprofit corporations' distributing profits to shareholders. Despite those restrictions, a nonprofit corporation can be beneficial because the income of a nonprofit corporation can be exempt from federal income tax, and people who donate money or property to the corporation can potentially receive a charitable tax deduction. Additionally, those working for the corporation can receive a wage or salary as compensation.

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.

LLCs, Corporations, Patents, Attorney Help

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 ...

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 ...

Deducting a Salary for a Single-Owner LLC

Creating a limited liability company for your business instead of operating it as a sole proprietor affects your ...

Can a Chapter C Corporation Carry Over to a Personal Tax Return?

Once you file the appropriate documentation to create a legal corporation in your jurisdiction, state and federal law ...

Browse by category
Ready to Begin? GET STARTED