Many business owners elect to have an “S Corporation” instead of another type of entity, but the IRS may have something to say about the owner’s paycheck!
Because the “S Corporation” allows all profits from the company to be taxed to the owners on their personal tax return, there can be huge savings on payroll tax. This is because the IRS assumes that you (the owner) are paying yourself a “reasonable” salary.
Remember that payroll taxes such as Medicare and Social Security add up to about 15.3% of your gross pay. But Medicare and Social Security Taxes are only calculated and paid on payrolls reflected in payroll tax returns and the year-end W-2 form. So, all the profits from your business after your paycheck are still taxable to you, but avoid the 15.3% payroll tax. Sounds good, right?
So what’s the big deal? Well many taxpayers have abused the system and the IRS won’t stand for it! Some owners pay themselves an unreasonable salary that is too low in order to avoid payroll taxes. This “salary lowballing” is cheating the tax system and will result in penalties and possibly jail time!
You need to do the things that support your salary as an owner. Corporate minutes are one way to document reasons that support your salary level. Documenting market-based salaries for the position you hold as an employee is another good idea. The IRS will hold you accountable to prove why you paid yourself the wages you did. So you should document this information every tax year. And as an added bonus from the IRS, family employees of the owners are scrutinized the same way!
Stan is an active Certified Public Accountant (N.C. Certificate #32076) in North Carolina. With over seventeen years of experience exclusively serving local, privately-owned businesses, he is passionate about helping business owners optimize their potential, be proactive, and solve crises. Call Stan P. Moore CPA at 919 ♦ 233 ♦ 0076 for a consult today. For more information or contact us here!