Shareholder-Employees: Must You Pay Yourself a Salary in a C-Corp or S-Corp?
As a shareholder-employee of either a C-Corporation (C-Corp) or an S-Corporation (S-Corp), you might wonder if you are required to pay yourself a salary. This article explores the key points you need to consider in each type of corporation.
C-Corporation
Salary Requirement: The IRS mandates that shareholder-employees providing services to the corporation must receive reasonable compensation for those services. This requirement is crucial, as the IRS scrutinizes salaries to ensure fairness and compliance.
For C-Corps, the determination of 'reasonable compensation' is based on the income level of the company and your role within it. The salary should be comparable to what other individuals in similar positions are paid in the industry.
Tax Implications: Salaries are subject to payroll taxes, including Social Security and Medicare taxes. These taxes are inevitable, but they can be offset by the corporation's ability to deduct the salary as a business expense. This deduction can reduce the corporation's taxable income, providing a financial benefit.
S-Corporation
Salary Requirement: Similar to C-Corps, S-Corps also require shareholder-employees to receive reasonable compensation for their work. Unlike C-Corps, S-Corps are even more closely watched by the IRS to prevent non-compliance.
Distributions vs. Salary: While you can take distributions from an S-Corp, these distributions are not subject to self-employment taxes. However, distributions must not be the primary means of receiving income from the corporation. Instead, you must pay yourself a reasonable salary before taking any distributions.
Non-compliance in S-Corps can lead to significant penalties and audits, as the IRS aims to ensure that shareholder-employees are not circumventing payroll taxes through distribution of profits instead of salary disbursements.
Conclusion
It is absolutely essential to pay yourself a reasonable salary if you are actively involved in the business. Compliance with IRS regulations is crucial to avoid penalties and potential audits. The determination of what constitutes a 'reasonable salary' can be subjective, but keeping records and maintaining a fair assessment of your compensation can help address any IRS scrutiny.
Key Insights: C-Corporations and S-Corporations have similar but slightly different requirements for shareholder-employee salaries. Salaries must be 'reasonable' and comparable to industry standards. Salaries provide deductions that can reduce taxable income, while distributions do not. Maintain records to support the reasonableness of your salary.
By following these guidelines, you can ensure compliance and potential tax benefits, avoiding penalties and audits.
Additional Resources: Understanding S-Corporations Understanding C-Corporations Self-Employment Tax Information
Stay informed and stay compliant to ensure the success and longevity of your business in a corporate structure.