Reasonable Wage For S-Corporation Shareholders

For those of you with S-Corporations, now is the time of year to look at your wage for the year-to-date as well as start the planning for 2009.  A “reasonable wage” needs to be paid to more than 2% shareholders in S-Corporation, and there is still time to make changes without incurring payroll tax penalties.

This is a crucial issue as an S-Corporation return without wages to the shareholder is pretty much a red flag to the IRS – especially if you took distributions during the year.  The law requires a “reasonable” wage be paid, but what is “reasonable”?

I have been through several IRS audits where this was brought into questions and the IRS answer is to look to the online salary guides and they are always going to look to the high side of the scale.  If you are in a state unemployment audit, they will magically select a wage equal or greater than the unemployment tax limit (in OR – $30,200 for 2008).  I believe most S-Corporation shareholders should be somewhat aggressive and argue for the lower side of the salary guide scale, but it does still need to be a reasonable figure that you can make a case for.   Basically, it should be the wage you would have to pay to hire someone to do your job.  In some industries, this is fairly easy to calculate using salary guides; however, many industries are very unique and salary guide data is not going to be as readily available.

At this point in the year, you can pay yourself just about any amount needed provided you pay your payroll tax monthly.  However, if you wait until December or only want to pay payroll tax quarterly, then the maximum you can pay yourself without incurring payroll tax penalties is $16,339.00 (assuming you do not have any Federal or State withholdings and you are the only employee).  Why such a specific number?  Well, the IRS payroll tax rules state that when your payroll tax liability is less than $2,500 for the quarter that you do not have to deposit monthly and can pay the tax due with the report, and $16,339 in wages gives you $2,499.88 in liability.  That means you can pay yourself this payroll amount (or reclassify distributions) as late as 12/31/07 and you will not have to pay the payroll tax liability until 1/31/08.

If you have taken funds out of your S-Corporation during the year (distributions) and have not paid any wages, please pay yourself some wages before year-end and save yourself potential problems with the IRS or your state unemployment agency.

For more information, refer to IRS Publication 15 and contact your CPA or accountant.  For payroll processing, feel free to contact our firm, Adrienne Derryberry at Paychex, or Dan Burke or Jaymie Steck at ADP.

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About Brian Germer, CPA

CPA with Parsons and Germer CPAs, LLP in Portland, OR

7 thoughts on “Reasonable Wage For S-Corporation Shareholders

  1. Brian, you may have touched on this in other posts, but must a “reasonable wage” be paid to S corp >2% shareholders where no distributions have been made to the shareholders during the year? The scenario I’m imagining, which I assume is probably common, is a startup company that does not generate enough income in its first year to pay any distributions or salaries.

  2. That is actually very common with startup companies that are organized as an S-Corporation. I have prepared many first year returns where the was not adequate cash flow to pay wages or distributions.

    My only caution would be to watch for items that are reclassified as distributions – personal transactions paid for by the corporation for the convenience of the shareholder; shareholder health insurance not reported in box 1 on a W-2; shareholder life/disability insurance; etc. From a reporting standpoint, these items can make it look as if the shareholder received cash distributions if some thought is not put into the tax preparation. There are several simple solutions I use that have worked well in the past, but every startup company is different.

    Any 1120S with a zero in the officer wage box is always going to be a flag to the IRS and something they are going to ask about in an audit, so documentation doesn’t hurt. Deferred wage documentation makes it an even stronger case, but as long as you can show that the cash flow was not there and that there were no other payments to the shareholder, then it should not be an issue – especially if wages start as soon as cash flow allows.

    btw, I like your blog – can I add it to my blogroll?

  3. That makes sense. Thanks for clearing it all up. Like so many other tax/corporate matters, good record keeping & documentation seem to play a large part in how the IRS will view the company’s transactions.

    Absolutely! I’ll add your blog to my blogroll as well.

  4. Hello Brian,

    I work for an S-Corp who has two shareholders, but do little to no work for the company as majority of the work is delegated to 4-5 paid employees. The shareholders have not received distributions, but made contributions through the year to keep the business running. The shareholders were paid a much smaller salary than the employees who work full time. Would this be a reasonable salary, considering the fact that they do not do much work and also have not made distributions to themselves? The S Corp did make a net profit in 2013. Thank you for your help

    • As long as there were no distributions, I think the shareholders are fairly safe given that fact pattern. Even if the IRS argued that the salaries were unreasonable based on the work performed, there would be no distributions to reclassify, so there is little they could do.

      My only caution would be to make sure there are no payments that the IRS could possibly reclassify as distributions. For example, if I was an auditor, I would look at the shareholder loans, expense reimbursements, and business auto use.

      – Make sure the shareholder loans are probably documented, and that they have interest calculated on them if over $10k. That way, if they start having the company repay the their loans, it is clear that they are loan payments.

      – Make sure expense reimbursements to the shareholders are adequately documented.

      – Lastly, make sure there are no personal expenses mixed with business expenses, especially with auto use. If there is a company vehicle that is used personally make sure only the business use is deducted/depreciated. Also, make sure commuting miles are accounted for.

  5. Is the $10K loan threshold a total for amounts loaned by a shareholder during the year or is it “per loan.” What if a shareholder made many loans during the year that sere less than $10K?

    • Total for the year – not per loan. Otherwise, you could always get around it by creating enough loans to be under the limit. If a shareholder has separate loans that they want to track separately, I just make them sub-accounts of a main loan from shareholder account in their accounting software – especially since it will all be reportable on one line on the tax return.

      Also, when applying the rule, you are considered over the limit if at any point during the year the balance was over $10k. You could be over for one day and the IRS would want to see interest accrued on the balance.

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