An S corporation shareholder-employee is required to earn at least a reasonable salary paid through a W-2. The W-2 wages will be subject to the normal payroll tax for both the employer and employee, which will include both Social Security and Medicare taxes. For 2015, the first $118,500 of wages is taxed at a combined rate of 15.3%. The employer Medicare tax rate of 1.45% will continue on any excess over the $118,500 threshold and will increase by .9% (to 2.35%) if an individual's earned income exceeds $200,000 ($250,000 for married couples filing jointly).
Conversely, an S corporation shareholder's distributive share of the corporation's net income is currently not subject to self-employment tax. The self-employment tax is a tax on nonwage-earned income that is equivalent to the employer and employee portion of the payroll taxes. In addition, if the shareholder materially participates in the business, as defined under the passive loss rules, the income also will not be subject to the additional 3.8% net investment income tax. Therefore, the S corporation should pay the shareholder-employee the minimum salary that is reasonable for the services performed. This means that taxpayers whose wages are in excess of the FICA maximum for the year can save the 3.8% tax on the S corporation profits (even more, if they are under the FICA maximum). Be sure to establish and document reasonable salaries for each position using compensation surveys, company financial data, and other evidence.
Questions? Please contact us to discuss your current compensation of S corporation shareholders.
Hal Zemel, a Tax Principal at Berdon LLP, has more than 20 years in public accounting and advises businesses in the real estate, service, and manufacturing sectors.