You are like any other responsible business owner; you want your business to succeed. However cutting corners by not paying yourself or your employees is the quickest way to end up in the auditor’s office. The IRS does not expect you or anyone else to work for free and that is why you must pay yourself and your officers a salary.
You must pay your owner-employees a reasonable salary and pay taxes on that salary for several reasons.
- You wouldn’t work for free or for less than minimum wage so the IRS is ensuring that you are making a wage (and getting paid for those wages).
- If no salary is paid the owner would side-step paying FICA payroll taxes since Profits of the S-Corporation are un-taxable by FICA. The IRS attacks S-Corporations because they are hoping to recover any unpaid payroll taxes.
- It is a big problem because S-Corporations pass on profits and losses to shareholders. S-Corporations don’t pay taxes through dividends like other corporations so the IRS ensures that they are getting their share of your money by taxing incomes/salaries.
Calculating your reasonable salary is simple if you keep in mind that:
- You must pay your owner-employees more than minimum wage
- You must take into account how many days/hours you work in the week your years of experience in that particular position and how much you contribute to the S-corporation.
- You must pay your owner-employees a wage that is similar to someone else working in the same position at another company. For example if you would make $75000 in a year working at another company you must be in the same range as that.
- You must not pay yourself more than an appropriate wage. If you would normally make $75000 at another company do not pay yourself $500000. This is more of a problem when you start to show a lot of net profits.
It doesn’t always make sense to pay yourself a salary and get taxed on your own money. This is especially true in the first few years of operation when you are likely to be showing loses. However paying salaries is not an option. A great rule to keep in mind is to wait to make your business an S-corporation until your business is showing enough profits to pay a reasonable salary.