Q: Tax Playa, I have recently opened an S-corporation and am confused about how to get money out of it. Do I need to pay myself a salary? If so, how do I do withholding?
Ales, Somewhere USA
A: Welcome to one of the biggest areas of the tax law that taxpayers often get wrong--the S-corporation "reasonable salary" trap. Many people (and those selling services) want to avoid self-employment tax by using S-corps, but there are several downsides to doing so--the biggest being this salary requirement, which is under intense scrutiny by the IRS and Congress...
To review my previous posting on S-corps, these allow business income to "pass through" to the owner, who pays taxes on the income on his or her personal return. While this avoids the double taxation of corporate income and (much of) the self-employment taxation of sole proprietorships and general partnerships, there are several downsides, including:
--Every dollar of business income is taxed at the marginal tax rate of the business owner, which can be as high as 35%
--Fringe benefits are not allowed, with an exception for pension plans and (in a convoluted way) health insurance costs
--There is a requirement to pay a "reasonable salary," the topic of our discussion today.
Why does the IRS require a reasonable salary to be paid? Because simply having your S-corp profit passed to your personal return avoids Social Security and Medicare taxation.
A reasonable salary is one "based on all the facts and circumstances" and one which is "comparable for similar work in your industry."
The best way to pay one is to hire a payroll company and pay yourself a minimal amount. The less you pay, the more you save in FICA.
Congress and the IRS has indicated they will be looking at S-corps with much greater scrutiny. If you skirt the law and fail to pay yourself a reasonable salary, the IRS may declare that all of your S-corp profit should have been salary. Better to pay a little FICA now than a lot of FICA later.
thank you for the info...
ok... question:
1. do you have or can you recommend a sample (pre-filled) estimated taxes 1040-ES form (that would be benefit the payee within legal means?)
2. what if you received 4 paychecks and did not do the payroll as you specified, what do you do to make up for that?
2a. do you recommend any specific payroll company in particular?
3. How do you determine profit in accordance to what you pay yourself? (when you have rent, advertising costs, etc... ) i.e. when you first start out your business it's usually not profitable for a while... how would you be able to afford to pay yourself when you made no profit? (especially if it's suppose to be compared to others in the same industry)
Posted by: Ales | 2007.03.15 at 06:11 PM
To answer:
1. Not sure I understand the question. The S-corp owner is responsible for paying estimated income tax quarterly (or having it withheld from his salary). This can be found on the 1040-ES on the IRS website, or by using the EFTPS system.
2. If that distribution was not salary, it was simply a reimbursement of costs. If it exceeds unreimbursed costs for the year, it draws on corporate profits. If it exceeds corporate profits, it draws down basis in the corporation. If basis in the corporation is zeroed out, it's a loan from the corporation to the shareholder.
3. I don't have any particular recommendations on payroll companies.
4. The profitability of the corporation is taken into account for reasonableness. If the corporation is in early buildup and has modest or no profits, then no salary would reasonably be paid.
Posted by: Ryan Ellis | 2007.03.15 at 09:16 PM
scratch #1 (i was looking at the 1040-ES form and wanted to see a pre-filled sample)
2. so what do i do (what form do i fill out, if any)? because i received the pay for 4 weeks straight, and my only business expenses consisted of home/office rent and utilities...
3. i just looked at quickbooks payroll... http://payroll.intuit.com ... (this will also go with #4) ... do you need to do payroll if you don't make a profit?
4. so how do you do your estimated taxes when you don't make a profit?
Posted by: Ales | 2007.03.16 at 01:12 AM
I have a home I bought from my mom. It is worth 160,000. I still owe her 65,000. She is on the deed because she refuses to take a risk taking her name off. I want to sell and have been in my home over 2 years. I don't want to pay tax on the income. Because she is on the deed can I still take the tax free income for living here 2 years?
Posted by: Deborah Ciangura | 2008.06.22 at 11:57 PM