Q:

Read your web article on s corps; very informative. However, I am confused about shareholders in an S corp who are on the payroll. If a shareholder is on the S corp payroll and receives a w2, would they not report and pay tax on that income also in addition to the Sched. K? Thank you if you have a chance to respond.

A:

It is correct that W-2 wages received will be reported on Line 7 of the 1040, and the net profit or loss from the S corp's K-1 will be reported on page 2 of the Schedule E.

If you are under the impression that this is reporting the same income twice, that is a wrong assumption.  The K-1 income is the net after deducting all W-2 wages paid, for shareholders and everyone else.

While income taxes on both K-1 and W-2 income are the same, in terms of overall tax burden, the W-2 wages are taxed much higher because they are also subject to the various federal, state, and local payroll taxes.  This leads to the constant game of having active shareholders taking out what they consider to be a "reasonable" salary as W-2 pay, and the rest of the profits as K-1 income.  On the other side of the fence is the IRS, which wants to consider as high a figure as possible for W-2 wages just so they can squeeze more payroll tax money out of the business.

People can go overboard on this in both directions.  What I have always felt was absolutely crazy are S corp shareholders who are so paranoid about IRS demanding something be classified as W-2 wages, when their corp is running net losses,  that they actually borrow money in order to pay themselves a salary, which they then turn right around and loan back to their corps.  That's insane, but IRS won't turn down the extra tax money they are volunteering to pay in under this strategy.

You and your professional tax advisor should work on the best game plan for your situation.

Kerry Kerstetter

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/13/2005 03:14:00 PM Send this post: