A December owner pay review for S corporation clients, without a percentage rule

Read the IRS pages linked here, Publication 15-B, and the facts in the file. Do not use this worksheet as a salary formula. There is no percentage in it on purpose. If you need a number, the practitioner who will sign the wage reporting and the 1120-S sets it. This firm page does not.

The IRS says S corporations must pay reasonable compensation to a shareholder employee for services provided to the corporation before nonwage distributions may be made to that shareholder employee. Reasonable compensation will never exceed the amount the shareholder received, directly or indirectly. The Form 1120-S instructions, as quoted by the IRS, say 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 IRS may reclassify distributions as wages subject to employment tax. (S corporation compensation and medical insurance issues)

An officer of a corporation is generally an employee. An officer who performs no services or only minor services, and who neither receives nor is entitled to receive any pay, is not considered an employee. Wages paid to you as an officer should generally be commensurate with your duties. The IRS may adjust both the corporation and the shareholder if the officer is underpaid for services provided. Public libraries may have reference sources with averages of compensation for various services. That is a research step, not a percentage of profit. (Paying yourself)

Distributions from earnings and profits are generally dividends. A below market loan to a shareholder or employee can be recast. You cannot make someone an independent contractor, including yourself as a corporate officer, merely by issuing Form 1099-NEC instead of Form W-2. (Paying yourself)

Pull this in December, before the last payroll you can still run for the year. One row per shareholder employee.

If YTD wages are zero and YTD distributions are not, that is the meeting. It is not a percentage problem. It is a facts problem. The IRS looks at what the shareholder did, and at the source of gross receipts.

The IRS says the key to reasonable compensation is what the shareholder employee did, by looking at the source of the S corporation's gross receipts: services of the shareholder, services of nonshareholder employees, or capital and equipment. To the extent receipts come from nonshareholder employees and capital and equipment, payments to the shareholder may be nonwage distributions. To the extent receipts come from the shareholder's personal services, payments should be wages. Administrative work the shareholder does for other income producing people or assets also points toward wages. A manager who does not personally produce receipts can still be in that category. (S corporation compensation and medical insurance issues)

Some factors the IRS lists in determining reasonable compensation:

• Training and experience
• Duties and responsibilities
• Time and effort devoted to the business
• Dividend history
• Payments to nonshareholder 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

A formula, if you use one, is the practitioner's formula on those facts. It is not a published IRS percentage of net income. Do not write a percent on the worksheet to make the owner feel done.

Health and accident insurance premiums paid on behalf of a more than 2 percent S corporation shareholder employee are deductible by the S corporation and reportable as wages on that person's Form W-2, subject to income tax withholding. A 2 percent shareholder here is someone who owns more than 2 percent of the outstanding stock, or stock with more than 2 percent of the combined voting power. Those additional wages are not subject to Social Security, Medicare (FICA), or FUTA if the premiums are paid under a plan or system for all or a class of employees (or employees and their dependents). Put the amount in box 1. Do not put it in boxes 3 and 5 in that case. (S corporation compensation and medical insurance issues)

Publication 15-B says the same fringe rule: do not treat a 2 percent S corporation shareholder as an employee for the accident or health exclusion. Include the value in wages subject to federal income tax withholding. You can exclude that value (other than payments for specific injuries or illnesses not made under a plan set up for all employees or a class of employees) from wages subject to social security, Medicare, and FUTA. (Publication 15-B)

For the shareholder to take the above the line deduction for medical care premiums, the IRS page says the coverage must have been established by the S corporation and the other self employed medical insurance rules must be met. If the shareholder or spouse was eligible for a subsidized health plan, that deduction is not allowed. If the shareholder bought the policy in their own name and paid it personally, the IRS says that above the line deduction is not allowed. If the corporation pays or reimburses and includes the premium in the W-2, the deduction can be allowed under Notice 2008-1 as that page describes. Get the premium from the invoice. Get it into box 1 before payroll closes. (S corporation compensation and medical insurance issues)

ACA, QSEHRA, HSA, and related health plan rules on that IRS page are easy to get wrong. This year end review flags the W-2 wages. It does not design the health plan. Send plan questions to whoever owns that advice.

Once W-2s are filed, a missed wage is an amended W-2 and amended employment returns. Do the worksheet in the first half of December. Run remaining payroll the practitioner directed. Then the W-2 checklist can include the health premium in box 1.

• Bookkeeper pulls YTD wages, distributions, and the premium invoice.
• Practitioner decides wages and whether a year end payroll run is needed.
• Owner answers the email below. Silence is not a decision.
• Nobody uses a percent of profit as the answer.

Send to each more than 2 percent shareholder employee, or to the owner who can answer for all of them.

Download the S corporation owner pay review worksheet. One row per shareholder. Leave the percent of profit column off on purpose. This worksheet is a process aid. It is not tax advice.

The tax season operator can draft the follow up when lines 1 through 5 are still blank. Your staff approve what goes out. Your CPA reviews and signs every return.