Some S Corporation owners may try to reduce their overall income taxes by taking most of their income in distributions while paying themselves an artificially low salary. But the IRS sees this tactic as an attempt to evade taxes. In the most serious cases, this can even be considered a crime. And if the IRS determines that you haven’t been paying yourself reasonable compensation, any non-qualified distributions could be reclassified as income—and subject to employment taxes, penalties, and fees.
To establish your reasonable salary, you should research what similar roles are paid in your industry and geographical area. This salary should reflect what you would pay an unrelated third party for the same services.
One source for this research is RCReports. Our reasonable compensation reports combine IRS criteria, court precedent, and a proprietary wage database to provide tailored, accurate, and legally defensible reports outlining reasonable compensation for a wide variety of industries and business types.
Declaring Your S-Corporation Salary on Your Taxes
When you’re an S Corp shareholder and employee, you need to declare your salary on your taxes correctly to ensure compliance with tax regulations. Here’s a general overview of how to declare your S-corporation salary on your taxes:
Form W-2
As an employee of the S Corporation, you’ll receive a Form W-2 from your company at the end of the tax year. This form summarizes your salary, wages, and withheld taxes. You’ll use the information on this form to report your salary on your personal tax return.
Personal Income Tax Return
The salary you receive as an employee of the S Corporation is reported on your personal income tax return. If you’re a shareholder-employee, you’ll likely file Form 1040 (U.S. Individual Income Tax Return) and include the information from your Form W-2.
Schedule E
Depending on your specific situation, you might also need to complete Schedule E (Supplemental Income and Loss) of your Form 1040. This schedule is used to report income or loss from rental real estate, royalties, partnerships, S Corporations, and more.
Social Security and Medicare Taxes
The salary you receive from the S Corporation is subject to Social Security and Medicare taxes, often referred to as FICA taxes. [1] However, as an S Corporation shareholder-employee, you are responsible for paying both the employee and employer portions of these taxes. [2] It’s important to note that in the case of the employer portion, it is typically covered by the S Corporation itself. This is in contrast to traditional employees, where the employer typically bears the responsibility for the employer portion of these taxes.
Estimated Taxes
Since the S Corp doesn’t withhold taxes from your salary, you’ll need to make estimated tax payments to cover your own income tax liability. [3] Estimated tax payments are typically made quarterly to the IRS.
