Tread carefully when determining compensation for S-corporation shareholder-employees.

By distributing profits in the form of dividends rather than salary, an S-corporation and its owners can avoid payroll taxes on these amounts. Because of the additional 0.9% Medicare tax on wages in excess of $200,000 ($250,000 for joint filers and $125,000 for married filing separately), the potential tax savings may be even greater than it once would have been. (S-corporation dividends paid to shareholder-employees generally won’t be subject to the 3.8% net investment income tax.)

But paying little or no salary to S-corporation shareholder-employees is risky. The IRS has targeted S corporations, assessing unpaid payroll taxes, penalties and interest against companies whose owners’ salaries are unreasonably low.

To avoid such a result, S corporations should establish and document reasonable salaries for each position using compensation surveys, company financial data and other evidence.

Do you have questions about compensating S-corporation shareholder-employees? Contact us — we can help you determine the mix of salary and dividends that can keep tax liability as low as possible while standing up to IRS scrutiny. We can be reached at at 607-272-5550 or info@swcllp.com.