This week examines the shareholder-employee relationship. When an S corporation owner performs substantial services for the corporation, compensation rules become a central compliance issue.
Learning Objectives
- Understand the distinction between shareholder and employee roles.
- Understand the concept of reasonable compensation.
- Distinguish W-2 wages from shareholder distributions.
- Identify factors that may influence a reasonable compensation analysis.
Primary IRS Materials
- IRS S Corporation Compensation and Medical Insurance Issues guidance
- Publication 15, Employer’s Tax Guide
- Instructions for Form 1120-S
Reasonable Compensation
An S corporation shareholder who performs services for the corporation may also be an employee. The corporation should not simply replace compensation for services with shareholder distributions in order to avoid employment taxes.
A reasonable compensation analysis may consider factors such as duties performed, time devoted to the business, experience, responsibilities, comparable market compensation, and the financial circumstances of the business.
Practice Exercise
Write a one-page description of the work performed by the owner of a fictional one-person S corporation. Include estimated annual hours and major responsibilities. Then research what a business might reasonably pay another worker to perform similar duties.
End-of-Week Goal
You should be able to explain why W-2 salary is payment for services, while a shareholder distribution is made in the person’s capacity as an owner.