A district court has concluded that an S corporation shareholder-employee’s $24,000 salary in 2002 and 2003 was unreasonably low, and allowed IRS to reclassify as salary over $67,000 in dividend payments to the officer during each of those years. The corporation will also owe nearly $49,000 in employment taxes on the reclassified dividend payments.
The case hinged on a few key facts. First, the taxpayer was an accountant, and was providing only personal services. Generally, much of the income from personal services should be declared as salary for an S-Corporation officer.
Second, the taxpayer took profit distributions of between $175,000 and $205,000 in each of the two years at issue, in comparison to his $24,000 salary. This ratio is closely considered by the IRS and the courts.
Finally, and likely most importantly, the taxpayer stated that he would not do the same level and intensity of work for anyone else for only a salary of $24,000 per year.
If you’re an S-Corporation officer, and you work in your business, the time is now to assure you have been declaring a reasonable amount of salary each year.