In order to stay in the good graces of the Internal Revenue Service (IRS), S-corporations must be careful to handle employment taxes properly. S-corporations are required to treat compensation to their shareholder-employees as wages in return for services that the employee provides to the company. Problems arise when companies instead try to categorize the compensation as a shareholder distribution in order to avoid self-employment taxes.
Administrative Work Performed by Employee-Shareholders Requires Compensation
Determining whether the shareholder-employee received reasonable compensation for the services provided depends upon where the gross receipts and profits derived from. If they came from services of a non-shareholder employee or capital and equipment of the business, it is reasonable that the shareholder would receive distributions in addition to his or her compensation. Alternatively, if the profits and gross receipts are derived from the shareholder’s personal services, most of the distribution should be classified as compensation.
Services provided by the shareholder-employee include administrative work that is performed for the other income-producing employees or assets of the company. For example, a shareholder may be working in the capacity of a manager, overseeing other employees who produce income for the company. This role is considered a service to the company, and the shareholder must be compensated accordingly. These wages are subject to employment taxes.
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