Answers · S corporations
S Corporation Salary vs. Distribution
A shareholder who performs substantial services generally must receive reasonable compensation as wages before non-wage distributions for those services.
This question is answered in full on the main page for it.
How it works
The rule, and what it turns on.
No fixed 60/40 rule exists in the Code. Duties, hours, training, comparable pay, business size and profitability are relevant; IRS can reclassify distributions as wages.
Example
A full-time owner pays $15,000 wages and takes $150,000 distributions while generating most revenue; the salary can be challenged if not supported by facts.
Common mistakes
What we see go wrong, and what we do instead.
- Zero/nominal wages.
- Using a fixed percentage as law.
A better approach
- Document duties, hours and market compensation annually.
Authority
Where this comes from, so you can check it.
IRC §§3121(d), 3306(i), 3401(c) and 1366(e); Form 1120-S instructions; IRS S Corporation Compensation guidance.
Relevant case law
Radtke v. United States, 895 F.2d 1196 (7th Cir. 1990) - S corporation payments labeled dividends were treated as
wages for services.
David E. Watson, P.C. v. United States, 668 F.3d 1008 (8th Cir. 2012) - unusually low shareholder-employee salary
supported IRS reclassification.
Veterinary Surgical Consultants, P.C. v. Commissioner, 117 T.C. 141 (2001) - shareholder/officer performing
substantial services was an employee for employment-tax purposes.
Educational information, not individualized tax advice. Treatment depends on your facts, entity classification and tax year, and IRS instructions change. Confirm your own position with us before relying on it. Mint Associates does not provide legal services.
Have this question about your own books?
Thirty minutes with someone who does this every day, and you will know where you stand. No obligation.