Hans Kasper, MS-CPA, PS

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The only valid reason to elect “S” corporation status for your business is to avoid the double taxation that occurs in a “C” corporation when the company is sold. 

The only valid reason to be a “C” corporation is to deduct out-of-pocket medical expenses coupled with the fact that your type of business will not be salable or will be salable for very little money.

Another reason that some people want to be an “S” corporation is to avoid social security taxes by taking all of the money out of the corporation as “S” distributions (dividends.)  While that may be partially valid, it is not 100% valid.

The IRS requires that the working owners of a corporation, be it a “C” or “S” corporation, have a reasonable compensation—not to high in a “C” corporation and not to low in an “S” corporation.  While there are no exact formulas on what a reasonable compensation amount should be; in “S” corporations, a rule of thumb (remember that a rule of thumb is not the law) is that the owner’s compensation should be 50% or more of net income before the owner’s compensation is deducted, or an amount equal to or greater than net income after the owner’s compensation is deducted.  Net income equals sales (revenue) less business expenses.

Example:

For payroll preparation, I recommend that you use a service such as Paychex or talk with you bank about their payroll service.  The secret is to avoid payroll tax penalties due to late payment and late filing.

The above calculations imply that you are keeping a set of books using a program such as QuickBooks, that the data is correct, and when December rolls around that you look at the Profit and Loss statement to determine if you should give yourself a bonus to make the above ratios above the 50% minimum.  If your profit is lower, then throughout the year, you should be issuing a smaller payroll check so that you do not pay too much in taxes by have too large of a payroll check.

Link to article from the Journal of Accountancy regarding S-Corp Wages

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This page was last updated on 05/13/2010

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