Q:

Subject: A take on the S-Corporation salary question

 

I was thinking about the terms "capital intensive" and "service" as applied to partnerships, and came up with this:

 

S-Corp 1: substantially all corporate revenue is derived from services performed by employee-shareholders. I am assuming here that S-Corp 1 doesn't make significant profit from billing for the services of non-shareholder employees. This might be a consultancy or architectural firm.

 

S-Corp 2: substantially all corporate revenue is derived from the use of capital (borrowed or contributed by the shareholders). A real estate or mortgage lending firm might be good examples.

 

When considering reasonable salaries for employee-shareholders, I would think that gross revenues being equal, S-Corporation 1 should pay much higher salaries than S-Corporation 2. Do you think this analysis is a reasonable position to take?

A:

That is a good way to look at the issue, and is actually what the "reasonable salary" consideration is all about.  IRS wants to make sure that income that results from the personal services of the company's owners is reported as earned income and hit with all of the additional payroll taxes that those are subject to. 

As you know, even when you have a very logical method of determining an appropriate amount of W-2 compensation, that is no guarantee that IRS in their insatiable lust for money, won't try to increase that amount and make you fight them to use your figures.

As I've mentioned several times in my blog, this is also the exact same debate over LLC K-1 income being subject to the 15.3% SE tax or not.  Fortunately, IRS hasn't been as aggressive in reclassifying LLC income as they have been with S corps, because they don't have as much legal support for doing so with LLCs.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/17/2006 10:32:00 AM Send this post: