Beware: S Corporation Payouts Are Wages

Are you an owner of a business entity formed as an S-Corporation? Do you withdraw funds without paying yourself through payroll? The tax court has said that these payouts are wages, and they are subject to payroll reporting and taxes.

In an S corporation, income passes to the shareholders who then pay taxes on their share of income on their personal tax returns. Owners of S Corporations often pay little (or no) wages to themselves but instead withdraw wages as distributions. Because of this, they would not pay many of the payroll taxes usually charged for wages and the IRS tends to challenge the type of compensation paid to officers not run through payroll.

In a recent case, a taxpayer in Minnesota who had her law firm operating as an S corporation and was the only shareholder did not pay herself wages run through payroll. However, in 2011 through 2013, there was another attorney who worked at the firm and earned a salary.

The Problem

The problem here comes with the fact that the payments reported by the taxpayer did not match the payments reported by the S corporation, which caused a red flag. While in 2011 the S corporation did report the wages to the other attorney, it did not report the $62,000 of her payments as wages subject to payroll tax.

In 2012, $73,000 was reported as income payments but not wages, and in 2013, $48,000 was claimed as other income by her and the S corporation, although they both did report some wage payments.

Typically for an S corporation firm with a sole shareholder, payments would be considered wages subject to payroll tax calculations. In this case the taxpayer tried to say that the money was not wages but withdrawals from the company and her only mistake was not paying self-employment taxes.

Bottom Line

I is not believable that a sole shareholder of an S corporation law firm did not provide any legal services throughout the year and receive payments which would be considered wages.

If you are performing services in your S Corporation, be sure to pay yourself a reasonable wage and submit all payroll taxes due. A fair amount is what you would pay someone else in your position to do the work.

Are you needing help deciphering payroll tax laws or assistance with payroll processing? We are here to help! Contact us for a quote and learn all of the services available to you and your small business. We can be reached at 310-534-5577 or contact@abandp.com.