Corporate officers are specifically included within
the definition of employee for FICA (Federal Insurance
Contributions Act), FUTA (Federal Unemployment Tax Act)
and federal income tax withholding under the Internal
Revenue Code. When corporate officers perform services
for the corporation, and receive or are entitled to
receive payments, their compensation is generally considered
wages. Subchapter S corporations should treat payments
for services to officers as wages and not as distributions
of cash and property or loans to shareholders.
S corporations are corporations that elect to pass
corporate income, losses, deductions, and credits
through to their shareholders for federal tax purposes.
Shareholders of S corporations report the flow-through
of income and losses on their personal tax returns
and are assessed tax at their individual income tax
rates.
The Internal Revenue Code establishes that any officer
of a corporation, including S corporations, is an
employee of the corporation for federal employment
tax purposes. S corporations should not attempt to
avoid paying employment taxes by having their officers
treat their compensation as cash distributions, payments
of personal expenses, and/or loans rather than as
wages.
This fact sheet clarifies information that small
business taxpayers should understand regarding the
tax law for corporate officers who perform services.
Who’s an employee of the corporation?
Generally, an officer of a corporation is an employee
of the corporation. The fact that an officer is also
a shareholder does not change the requirement that
payments to the corporate officer be treated as wages.
Courts have consistently held that S corporation officer/shareholders
who provide more than minor services to their corporation
and receive or are entitled to receive payment are
employees whose compensation is subject to federal
employment taxes.
The Treasury Regulations provide an exception for
an officer of a corporation who does not perform any
services or performs only minor services and who neither
receives nor is entitled to receive, directly or indirectly,
any remuneration. Such an officer would not be considered
an employee.
What's a Reasonable Salary?
The instructions to the Form 1120S, U.S. Income Tax
Return for an S Corporation, state "Distributions
and other payments by an S corporation to a corporate
officer must be treated as wages to the extent the
amounts are reasonable compensation for services rendered
to the corporation."
The amount of the compensation will never exceed
the amount received by the shareholder either directly
or indirectly. However, if cash or property or the
right to receive cash and property did go the shareholder,
a salary amount must be determined and the level of
salary must be reasonable and appropriate.
There are no specific guidelines for reasonable compensation
in the Code or the Regulations. The various courts
that have ruled on this issue have based their determinations
on the facts and circumstances of each case.
Some factors considered by the courts in determining
reasonable compensation:
Medical Insurance Premiums treated as wages.
The health and accident insurance premiums paid on
behalf of the greater than 2 percent S corporation
shareholder-employee are deductible by the S corporation
as fringe benefits and are reportable as wages for
income tax withholding purposes on the shareholder-employee’s
Form W-2. They are not subject to Social Security
or Medicare (FICA) or Unemployment (FUTA) taxes. Therefore,
this additional compensation is included in Box 1
(Wages) of the Form W-2, Wage and Tax Statement, issued
to the shareholder, but would not be included in Boxes
3 or 5 of Form W-2.
A 2-percent shareholder-employee is eligible for
an AGI deduction for amounts paid during the year
for medical care premiums if the medical care coverage
is established by the S corporation. Previously, “established
by the S corporation” meant that the medical
care coverage had to be in the name of the S corporation.
In Notice 2008-1, the IRS stated that if the medical
coverage plan is in the name of the 2percent shareholder
and not in the name of the S corporation, a medical
care plan can be considered to be established by the
S corporation if: the S corporation either paid or
reimbursed the 2percent shareholder for the premiums
and reported the premium payment or reimbursement
as wages on the 2percent shareholder’s Form W-2.
Payments of the health and accident insurance premiums
on behalf of the shareholder may be further identified
in Box 14 (Other) of the Form W-2.
Schedule K-1 (Form 1120S) and Form 1099 should not
be used as an alternative to the Form W-2 to report
this additional compensation.
Page Last
Reviewed or Updated: November 19, 2008
Information
provided courtesy of the IRS
