How Low Can You Set S Corporation Shareholder-Employee Salaries?

Obviously, the big savings from an S corporation come from setting salaries for shareholder--employees to some reasonable yet low figure. Everybody knows that--accountants, attorneys, small business owners and (of course) the Internal Revenue Service.

The big question, of course, is how low can you go?

Unfortunately, and maybe predictably, you will not get any definitive answers about how low you can go.

I can, however, provide you with several useful tips to help with setting a reasonably low salary for the shareholder-employee.

S Corp Salary Tip #1: Know the Statistics

You may as well know that many profitable S corporations probably set the salaries of shareholder-employees to zero. Every so often, for example, the Treasury's Inspector General (essentially, the guy who audits the auditors) issues a report on the ways S corporations and their owners comply with US tax laws. Typically, the Inspector General reports that tens of thousands of profitable small S corporations pay no wages to shareholder-employees.

Note: The IRS annually examines (audits) about ten thousand S corporations. One can only conclude, therefore, that tens of thousands of S corporations seem to get away with paying their shareholder-employees nothing.

S Corp Salary Tip #2: Look at the Averages

Look at the average compensation paid by S corporations to shareholder-employees. The IRS provides this salary statistic at its www.irs.gov website. In recent years, the average shareholder-employee salary paid by an S corporation runs roughly $40,000 a year. Obviously, large numbers of S corporations are paying their shareholder-employee modest wages. In fact, roughly half the S corporations in the country pay their shareholder-employees less than 40,000 dollars a year.

S Corp Salary Tip #3: Reference Real Comparisons

Review government databases of the salary information. The Bureau of Labor Statistics web site at www.bls.gov gives average salary data for most job positions. Sometimes, this reported salary seems low (at least to taxpayers living on either coast). But no matter. The IRS and your tax accountant will probably have a very difficult time arguing that the number you have pulled out from the Bureau of Labor Statistics is unreasonably low. And that'll probably be true even if the the salary you pick saves you a great deal with a payroll tax.

S Corp Salary Tip #4: Ask Around About a Local Safe Harbor

Research the possibility of local safe harbor salary for an S corporation salary. In some areas of the country, tax accountants will tell you--strictly off the record, of course--that IRS agents seem to have a unofficial safe harbor amount. If such a safe harbor exists in your area, you probably want to pay shareholder-employees at least this amount.

S Corp Salary Tip #5: Look at Rest of Your Return

Be sure to consider your low salary in relation to the rest of the information reported on your S corporation tax return. A good tax accountant can suggest return preparation options that support a lower salary. For example, an employee- provided pension plan contribution paid by the S corporation effectively lowers the salary you need to pay yourself as an S corporation shareholder-employee.

S Corp Salary Tip #6: Confer with Your Accountant

Ask your tax accountant. He or she needs to sign your tax return. Accordingly, he or she needs to feel comfortable with the shareholder-employee salaries you set. I think you'll find that most knowledgeable S corporation tax accountants also have unofficial "safe harbor" salaries--amounts which you probably need to exceed in order to get them to prepare and sign your return.

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