What is a reasonable salary?
The IRS and tax courts have been increasing the number of S corporations they go after over low partner salaries. Many owners of S companies purposely take below norm salaries so the bulk of the profits are passed through to their personal returns free of Social Security and Medicare taxes.
In a recent case, an accounting firm owner took a $24,000 salary from the S corp in a year when the owner’s share of the partnership’s profits was $203,000. An Appeals Court agreed with the IRS that the pay was unreasonably low, and that his services were worth $91,000. As such, $67,000 of the profits were reclassified as salary and subject to payroll taxes. They were required to pay a tax deficiency judgment which included unpaid employment taxes, penalties, and interest in the amount of $23,431.23.
We encourage you to be careful about pushing the tax envelope, as we anticipate the IRS to step up their enforcement efforts in the years to come.