The number one audit risk that S-Corporations have to deal with is salary and wages paid to officers of there corporation. One of the fastest ways for the IRS to audit an S-Corporation is to file an 1120S tax return with no amount showing on Line 7. It is assumed by the IRS that no one works for free, and by that being said the IRS has made it clear that officers of the corporation must receive wages in a profitable enterprise. So as an owner of the corporation, you need to pay yourself a salary, pay payroll taxes on that salary that you set for yourself. The salary that you pay for yourself does not need to be high, but however it does need to be a “reasonable amount” according to the IRS.
Compensation of an officer should be based on the same criteria as what you would pay someone to do the job that you do. Things that should be remembered when setting the salary is prevailing market rates, the individual’s knowledge skills, and abilities to do the job efficiently, amount of hours worked, and other factors that involves the line of work that goes with the corporation. Also, salary is reasonable if a non-officer would be willing to take a job that is set at a proposed salary level.
Generally, the IRS will allow the corporation a set of standards for setting the compensation for the officers-employees. However, the salary must be paid and the level that the salary is set at must be reasonable. Zero salary is unreasonable, NO one works for free. You would not want to persuade an employee to accept a job offering below what minimum wage is.
The IRS can collect payroll taxes on an officer’s compensation, and the penalty for falling to pay payroll taxes is 100% of the taxes owed by the corporation. To avoid this payroll tax penalty each officer and the employees should be paid a reasonable compensation.
Financial Accounting Services not only specializes in corporation taxes but payroll as well. Give our office a call at 951-719-1515 to book your tax appointment.