Tip of the Day: S Corporation Owners Must Take Reasonable Salary

Here’s interesting analysis by Cole Schotz of a recent IRS court case win that should sound a note of caution for all S Corporation owners:

“David Watson, a CPA in Des Moines, Iowa, set up an S corporation which was a principal in a four member accounting firm. In 2002 and 2003, the accounting firm made profit distributions to Watson’s S corporation of approximately $204,000 and $175,000 respectively. In those years, Watson reported a mere $24,000 of salary and the rest as S corporation profit, saving over $20,000 in payroll taxes.

The IRS disagreed with this reporting position, arguing that recent accounting graduates with no experience had average salaries at the time of approximately $40,000 per year, and that Watson’s reasonable salary was approximately $91,000. The District Court for the Southern District of Iowa agreed, ordering Watson to pay back taxes, interest and penalties.

This case may be viewed as an IRS victory, and it demonstrates that S corporation owners must take a reasonable salary. Nonetheless, the case also demonstrates the benefit of the S corporation structure. Had Watson organized as an LLC, all of the profits distributed would have been subject to payroll tax…”

Read the entire alert: S Corporation Owners Must Take Reasonable Salary | Cole Schotz