Four Consequences of Paying Unreasonable Compensation for Services to an S-Corporation

For the past ten years, you have owned and operated a consulting business in downtown Norman. Your business is an S-corporation, and you are both a shareholder and an employee of the business. Attempting to get around employment taxes by characterizing payments to yourself as shareholder distributions rather than wages can get you in trouble with the Internal Revenue Service (IRS).

What Happens When the IRS Says Compensation Was Unreasonable

It is certainly acceptable for shareholders to receive distributions from an S-Corporation. However, when the shareholder also provides services to the company, a reasonable amount of compensation must be paid to the employee-shareholder in the form of taxable wages. If the IRS suspects that the amount of money you deemed a distribution is unreasonable, you could face consequences. The following actions may be taken by the IRS:

  1. Re-characterize the distributions made to the employee-shareholder as taxable wages.
  2. Require you to pay employment taxes on the re-characterized distributions.
  3. Impose penalties, including payroll tax penalties, equal to up to 100% of the tax.
  4. Impose negligence penalties if the IRS concludes that you paid yourself unreasonably low compensation for the services that you provided to the company.

 

Shareholders who are employees wear two hats. Their first role is as an owner of the company. Their second role is an employee of the company who provides services. Since the business could face costly tax penalties for mischaracterizing distributions and wages, it is important to pay close attention to the IRS rules relating to S-corporations and employment taxes.

If you have already found yourself in trouble with the IRS, you are likely feeling overwhelmed and stressed. Fortunately, we can offer valuable assistance. Help is just an email away. Send us a message at anytime, day or night, when it is convenient for you. We will contact you to set up a consultation and get you on the road to IRS tax problem relief.