S Corporation Owners Must Take Reasonable Salary


One of the benefits of an S corporation ownership structure is a payroll tax advantage. An S corporation owner will pay payroll tax on his or her salary, but not on the entire amount of corporate profit. For example, if a corporation’s profit would be $500,000 without factoring in the owner’s salary, and the owner takes $200,000 as compensation and shows $300,000 in profit, only the salary amount is subject to payroll tax. This is one of the benefits S corporations have over LLCs, where all company profit is considered self-employment income and subject to payroll tax. (A legislative proposal to change this treatment recently failed to pass.)

This advantage may encourage S corporation owners to take less in salary and more in profit so as to save payroll taxes, but a recent case [David E. Watson, P.C. v US, 107 AFTR 2d ¶2011-305 (S D IA, December 23, 2010)] shows that salary still must be reasonable.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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