The IRS requires S corporation shareholders to pay themselves a “reasonable wage.” Reasonable wages are left strategically vague so that the IRS can audit and recharacterize distributions/draws as wages.
You do not need to panic or be anxious about how to determine what a reasonable wage should be. It is all about the ratio between distributions/draws on your S corporation balance sheet and officer compensation expense. When the IRS robots go out looking over S corporation tax returns, they are looking for extremely out of balance ratios of distributions to officer compensation expense.
Example 1 – If you take $100,000 in shareholder distributions and $0 in officer compensation/wages that would not be reasonable.
Example 2 – If you take $60,000 in shareholder distributions and $40,000 in officer compensation/wages that would be reasonable. A 40% payroll percentage is more reasonable than 0% if example 1 above.
It is important to understand that the percentage of payroll for the shareholder is determined from distributions and not net profit. If you happen to be independently wealthy and do not need to take distributions out of the business checking account to your personal account to live on, you do not need to take a reasonable wage. The IRS can only recharacterize distributions as officer compensation/reasonable wages. If there are no distributions, there is nothing to recharacterize.
Please book a discovery call to find out how we can help you save on taxes and increase your net worth.
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Reducing Taxes – Increasing Wealth
Please understand that I cannot give you specific investment or legal advice, just guidance in these areas, and you should consult a professional licensed in these areas for specific advice before making any final decisions.
