Are S Corps Required to Pay Salaries to their Shareholders
If an S corp has multiple shareholders, but many aren’t actively working in the business, it is not required to pay them a salary. Those shareholders will receive distributions that are not subject to self-employment taxes.
If a shareholder works in the company, they must pay themselves a reasonable wage for their functions and have payroll taxes deducted from their paychecks. Fortunately, the company’s portion of the payroll taxes is a tax write-off.
Determining a Reasonable Salary for Your Shareholders
If a shareholder works within the business, they must be paid a salary that is equivalent to the level of expertise, amount of work, and position in which they work. Some considerations when determining what is a reasonable salary would be:
- Duties and responsibilities
- Training or required experience
- Amount of time and effort dedicated to the business
- Compensation agreements
- How bonuses are paid to key people
- Industry
If the shareholder is working 60 hours a week as the company’s president and the job requires specific knowledge or skills, that owner needs to ask how much would be paid to someone else to assume that position. If the shareholder is doing a $100,000 per year job, paying themself $24,000 per year would be inappropriate, whereas paying themself $200,000 per year would result in excessive employment taxes being unnecessarily paid.
Should the IRS find the shareholder is deliberately underpaying themself, it could assess taxes to be paid on what would be considered the reasonable salary plus potential fines and interest.
S Corp Reasonable Salary Examples
Reasonable salary comes down to the job requirements and specialized skills or education required but also considers the amount of money the company makes. Should the company only make $20,000 annually and the S corp shareholder works 40 hours weekly, the owner would take all profits as a salary.
Should the company make $5 million per year, it would be unnecessary for the shareholder/employee to use the 50/50 rule if reasonable compensation for someone in their role is $250,000/year. Paying compensation of $2.5 million a year means far too much is being paid in payroll taxes.
Let’s say one shareholder works in the business full-time as a receptionist, whereas the other shareholder works as the company president. Compensation for each must be calculated as what would be paid when hiring an employee for that position. For instance, a company’s president’s compensation might align with an annual salary of $100,000, reflecting a higher pay scale within the workforce, whereas the receptionist’s compensation could be set at $40,000.
In this example, if both shareholders receive another $100,000 in distributions, they only pay payroll taxes on their reasonable salaries.
