The Application of Employment Taxes to S Corporation Shareholders-What Is "Unreasonably Low" Compensation?

"Unreasonably low" compensation paid to S corporation shareholder-employees has become a significant issue. S corporations often attempt to eliminate or minimize employment taxes by making a tax-free distribution to shareholder-employees instead of paying them salary. The IRS is giving inc...

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Bibliographic Details
Published inTaxes Vol. 85; no. 1; p. 19
Main Author Koski, Timothy R
Format Trade Publication Article
LanguageEnglish
Published Riverwoods CCH INCORPORATED 01.01.2007
Subjects
Accounting
Business income
C corporations
Closely held corporations
Compensation
Corporate distributions
Corporate tax planning
Court decisions
Dividend distributions
Employees
Employers
Federal court decisions
Limited liability companies
Payroll taxes
S corporations
Self employment
Sole proprietorships
Stockholders
Tax avoidance
Taxes
Taxpayers
Wages & salaries
United States > US
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Summary:"Unreasonably low" compensation paid to S corporation shareholder-employees has become a significant issue. S corporations often attempt to eliminate or minimize employment taxes by making a tax-free distribution to shareholder-employees instead of paying them salary. The IRS is giving increased audit scrutiny to this issue and will reclassify an S corporation distribution as salary subject to employment taxes when the S corporation pays the shareholder receiving the distribution no or an "unreasonably low" salary. There is considerable uncertainty as to what constitutes an "unreasonably low" salary, and practitioners are not adequately informed of the developing law in this area. No one factor is determinative of whether an S corporation distribution will be re-characterized as wages subject to employment tax. Courts will analyze all relevant factors in making this determination. One thing is clear, however: an S corporation with a shareholder who performs significant services for the corporation while receiving no salary will be carefully scrutinized by the IRS and the entire amount of any distribution received by the shareholder is likely to be re-characterized as wages subject to employment tax.
ISSN:0040-0181