Wage Compensation for S Corporation Officers

FS-2008-25, August 2008

Corporate officers are specifically included within the definition of employee for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act) and federal income tax withholding under the Internal Revenue Code. When corporate officers perform services for the corporation, and receive or are entitled to receive payments, their compensation is generally considered wages.  Subchapter S corporations should treat payments for services to officers as wages and not as distributions of cash and property or loans to shareholders.

S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.  Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates.

The Internal Revenue Code establishes that any officer of a corporation, including S corporations, is an employee of the corporation for federal employment tax purposes.  S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages.

This fact sheet clarifies information that small business taxpayers should understand regarding the tax law for corporate officers who perform services.

Who’s an employee of the corporation?

Generally, an officer of a corporation is an employee of the corporation.  The fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages. Courts have consistently held that S corporation officer/shareholders who provide more than minor services to their corporation and receive or are entitled to receive payment are employees whose compensation is subject to federal employment taxes.

The Treasury Regulations provide an exception for an officer of a corporation who does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration. Such an officer would not be considered an employee.

What's a Reasonable Salary?

The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."

The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly.  However, if cash or property or the right to receive cash and property did go the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate.

There are no specific guidelines for reasonable compensation in the Code or the Regulations. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of each case.

Some factors considered by the courts in determining reasonable compensation:

• Training and experience

• Duties and responsibilities

• Time and effort devoted to the business

• Dividend history

• Payments to non-shareholder employees

• Timing and manner of paying bonuses to key people

• What comparable businesses pay for similar services

• Compensation agreements

• The use of a formula to determine compensation

Medical Insurance Premiums treated as wages.

The health and accident insurance premiums paid on behalf of the greater than 2 percent S corporation shareholder-employee are deductible by the S corporation as fringe benefits and are reportable as wages for income tax withholding purposes on the shareholder-employee’s Form W-2. They are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes. Therefore, this additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement, issued to the shareholder, but would not be included in Boxes 3 or 5 of Form W-2.

A 2-percent shareholder-employee is eligible for an AGI deduction for amounts paid during the year for medical care premiums if the medical care coverage is established by the S corporation.   Previously, “established by the S corporation” meant that the medical care coverage had to be in the name of the S corporation.

In Notice 2008-1, the IRS stated that if the medical coverage plan is in the name of the 2percent shareholder and not in the name of the S corporation, a medical care plan can be considered to be established by the S corporation if: the S corporation either paid or reimbursed the 2percent shareholder for the premiums and reported the premium payment or reimbursement as wages on the 2percent shareholder’s Form W-2.

Payments of the health and accident insurance premiums on behalf of the shareholder may be further identified in Box 14 (Other) of the Form W-2.
Schedule K-1 (Form 1120S) and Form 1099 should not be used as an alternative to the Form W-2 to report this additional compensation.

Looking for a new job? You may be able to deduct the cost of your job search on your tax return.

If you’re one of the many people searching for a job right now, you may be able to deduct some of your expenses, such as attending career fairs, on your tax return as long as you are looking for a new job in your current occupation. Here are a few things to keep in mind:

· Job search expenses fall into the category of miscellaneous itemized deductions on Schedule A, Itemized Deductions. If your total itemized deductions are higher than the standard deduction, it is generally better to choose to include your itemized deductions. Also, in most cases these expenses must exceed your adjusted gross income by 2 percent to provide a tax benefit.

· Your expenses must be spent on a job search in your current occupation. You may not deduct expenses incurred while looking for a job in a new occupation.

· You can deduct the fees you pay for employment and outplacement agencies. If your employer pays you back in a later year for these fees, you must include the amount in your gross income up to the amount of your tax benefit in the earlier year.

· You can deduct amounts you spend for preparing and mailing copies of a résumé to prospective employers.

· If you travel to a different area to look for a new job, you may be able to deduct travel expenses to and from that area. You can deduct the travel expenses only if the trip is primarily to look for a new job. The amount of time you spend on personal activity compared to the amount of time you spend looking for work is important in determining whether the trip is primarily personal or primarily to look for a new job.

· You cannot deduct job search expenses if there was a substantial break between the end of your last job and the time you begin looking for a new one.

· You cannot deduct job search expenses if you are looking for a job for the first time.

For more information about job search expenses, read IRS Publication 529,Miscellaneous Deductions. This publication is available at the IRS website, IRS.gov, or by calling 800-TAX-FORM (800-829-3676).

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NOTE TO EDITOR: Below are links to IRS publications, tax topics and videos describing the tax benefits available to people searching for jobs.

· IRS Publication 529, Miscellaneous Deductions

· Tax Topic 508, Miscellaneous Expenses

· Tax Topic 511, Business Travel Expenses

· YouTube: Job Search Expenses: English, Spanish, ASL

Use IRS Withholding Calculator to adjust your withholding

As of March 18, the Internal Revenue Service had issued more than 63 million refunds with an average refund of $3,004.

The larger the tax refund you receive, the more money you’ve paid throughout the year because your withholding does not accurately reflect the tax you owed. Of course, there are some exceptions, such as special tax credits, that may be the cause of a larger refund. On the other hand, you could have owed tax when you filed your tax return this year. Either way, it may be time to evaluate your tax withholding and determine whether or not it needs to be adjusted.

If you are an employee, the IRS Withholding Calculator can help you determine whether you need to give your employer a new Form W-4, Employee’s Withholding Allowance Certificate, to avoid having too much or too little federal income tax withheld from your pay. You can use your results from the calculator to help fill out the form. You’ll find the IRS Withholding Calculator located at www.irs.gov — just enter the word calculator in the search box. You can also use the Form W-4 worksheets in Publication 919, How Do I Adjust My Tax Withholding?

Major life changes also could mean a necessary change in your withholding. Marriage, divorce, death of a dependent, and the birth or adoption of a child are all life changes that can result in a need to change the number of exemptions you claim on your W-4. Check your withholding if you had personal or financial changes in your life or if there were changes in the law that might affect your tax liability.

You may want to consider using the IRS Withholding Calculator to reevaluate your tax withholding for 2011, your estimated tax payments or both.

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Related Items on IRS.gov

• Publication 919, How Do I Adjust my Tax Withholding?
• IRS Withholding Calculator
• Form W-4, Employee’s Withholding Allowance Certificate

Are you an employee, self-employed or an independent contractor? Find out the difference.

The question of whether you are an employee or a self-employed independent contractor is very important and may not always be easy to answer. You should understand the category you fall under, since it'll affect how you pay your taxes.

You are an employee if –

Your payer has the right to direct and control your activity. The factors of control fall into three key categories:

• Behavioral control
• Financial control, and
• The relationship between you and your payer.

No one single fact determines worker classification, rather all of the facts and circumstances of a relationship weigh in the correct worker classification determination.

If you are an employee, you are required to report the wages you received during the calendar year on your personal income tax return because they are taxable income. Your employer is required to report wages paid to you during the year on a Form W-2. Your employer is also required to ask you to fill out a Form W-4 and you are required to return that form to your employer. Form W-4 directs your employer on how much tax to withhold from your pay. If you are unsure how much to request be withheld on your Form W-4, check the IRS Withholding Calculator for guidance.

You are an independent contractor if –

You have the right to direct and control the most important aspects of your activity.

People such as contractors, subcontractors and auctioneers, who maintain an independent trade, business or profession in which they offer their services to the public, are generally independent contractors.

If you are an independent contractor, your income earned will be reported to you by the payer on a Form 1099-MISC, unless the payer pays you less than $600 in the calendar year. However, you must report all the income you earned during the year, even if your client does not issue a Form 1099-MISC for your services.

As an independent contractor you are self-employed and are generally required to attach a business return to the annual income tax return that you file and to pay estimated tax quarterly. Self-employed individuals generally have to pay self-employment tax (Social Security and Medicare tax) as well as income tax. To read more on your tax obligations or for more information on estimated tax, go to the Self-Employed Individuals Tax Center on IRS.gov.

If your worker status is unclear –

You or your payer can file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS to help determine your status.

Additionally, The IRS developed Form 8919, Uncollected Social Security and Medicare Tax on Wages, to simplify the process for employees to report their share of uncollected Social Security and Medicare taxes due on their compensation when their employers have misclassified them as independent contractors.

Tax Tips: Record Keeping

Six Facts the IRS Wants You to Know about the Alternative Minimum Tax

 
The Alternative Minimum Tax attempts to ensure that anyone who benefits from certain tax advantages pays at least a minimum amount of tax. The AMT provides an alternative set of rules for calculating your income tax. In general, these rules should determine the minimum amount of tax that someone with your income should be required to pay. If your regular tax falls below this minimum, you have to make up the difference by paying alternative minimum tax.
Here are six facts the Internal Revenue Service wants you to know about the AMT and changes for 2010.
1. Tax laws provide tax benefits for certain kinds of income and allow special deductions and credits for certain expenses. These benefits can drastically reduce some taxpayers’ tax obligations. Congress created the AMT in 1969, targeting higher-income taxpayers who could claim so many deductions they owed little or no income tax.
2. Because the AMT is not indexed for inflation, a growing number of middle-income taxpayers are discovering they are subject to the AMT.
3. You may have to pay the AMT if your taxable income for regular tax purposes plus any adjustments and preference items that apply to you are more than the AMT exemption amount.
4. The AMT exemption amounts are set by law for each filing status.
5. For tax year 2010, Congress raised the AMT exemption amounts to the following levels: 
$72,450 for a married couple filing a joint return and qualifying widows and  widowers;
$47,450 for singles and heads of household;
$36,225 for a married person filing separately.
6.  The minimum AMT exemption amount for a child whose unearned income is taxed at the parents'  tax rate has increased to $6,700 for 2010.
Use the IRS AMT Assistant to determine whether you may be subject to the AMT. Taxpayers can find more information about the Alternative Minimum Tax and how it impacts them by accessing IRS Form 6251, Alternative Minimum Tax —Individuals, and its instructions at http://www.irs.gov or by calling 800-TAX-FORM (800-829-3676).
 
Links:
AMT Assistant
IRS Form 6251, Alternative Minimum Tax—Individuals

Ten Facts for Mortgage Debt Forgiveness

If your mortgage debt is partly or entirely forgiven during tax years 2007 through 2012, you may be able to claim special tax relief and exclude the debt forgiven from your income. Here are 10 facts the IRS wants you to know about Mortgage Debt Forgiveness. Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence. The limit is $1 million for a married person filing a separate return. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7. For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit IRS.gov. A good resource is IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments. Taxpayers may obtain a copy of this publication and Form 982 either by downloading them from IRS.gov or by calling 800-TAX-FORM (800-829-3676). Links: Form 982 Form 1099-C