S Corporation Reasonable Compensation Tips

July 28, 2014 | By | Reply More

S corporation reasonable compensation

Subchapter S corporation reduce substantially the payroll, or employment taxes, that business owners pay when shareholder salaries get set to a modest level.

But you need to be reasonable. The IRS watches S corporation shareholder-employee salaries very, very closely. Fortunately, you can use several tricks to effectively push down the salary you need to pay yourself.

S Corporation Salary Tip #1: Correctly Account for Shareholder Health Insurance

One easy way to effectively set the salary of shareholder-employee to a low level is to correctly account for self-employed health insurance.

Here’s the deal: In an S Corporation amounts paid to shareholders for health insurance count as salary. However, amounts paid as health insurance don’t get subjected to Social Security or Medicare taxes.

 
RELATED: How to Issue Employee Stock Options for an S-Corporation
 

Accordingly, if you do the accounting right for health insurance provided to shareholder-employees, you in effect boost the reported salary amounts but without increasing payroll costs. This means you save payroll taxes.

Example: If an S corporation pays a shareholder-employee $40,000 in wages and provides $10,000 of health insurance, the total wages reported should be $50,000. Note, however, that only $40,000 of this money will be subjected to payroll taxes.

S Corporation salary Tip #2: Consider a Simplified Employee Pension Plan

Another effective way to support a lower salary for a shareholder-employee in an S Corporation is to use a pension plan option based on employer contributions rather than on employee contributions. This works because employer contributions end up being deductions both for income taxes and payroll taxes.




Something like a Simplified Employee Pension plan, or SEP-IRA plan, does this wonderfully well, for example. If a shareholder-employee makes $40,000 a year, the maximum Simplified Employee Pension plan contribution equals 25%, or $10,000, a year.

However, the $10,000 though counting as compensation is not subject to Social Security or Medicare tax. (By the way, the pension contribution also isn’t subject to income taxes.)

S Corporation Salary Tip #3: Be Conservative But Not Greedy

One final tip is in order: You can be conservative about setting shareholder-employee salaries. The recent tax court case of CPA David Watson essentially confirms the approach where an S Corporation sets a low-end-of-the-range salary. (In the Watson tax court case, the court accepted roughly a $90,000 salary for a CPA making nearly $250,000 a year in his accounting practice.)

 
RELATED: Forming an LLC and Electing to be Taxed as an “S” Corp
 

Don’t, however, get too greedy. The S corporation tax return makes it very easy for the Internal Revenue Service to spot outrageously low salary levels. Remember the old adage: pigs get fat but hogs get slaughtered.

 
Recommended Books on S Corporation

 

 

Stephen Nelson

Stephen L. Nelson CPA provides more information about the advantages of an S corporation at his http://www.scorporationsexplained.com/ web site. Nelson has also authored best-selling books about both Quicken and QuickBooks and specializes in S corporation taxes.

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S Corporation Reasonable Compensation Tips
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Subchapter S corporation reduce substantially the payroll, or employment taxes, that business owners pay when shareholder salaries get set to a modest level. But you need to be reasonable. The IRS watches S corporation shareholder-employee salaries very, very closely.
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