S-Corporation Compensation Revisted

In May I wrote about a friend of mine who owns an S-corporation and who received bad advice from his CPA regarding the salary rules for S-corps.

My friend’s corporation took in about $25,000 of gross income and netted about $10,000 after expenses. He drew out nearly all of that $10,000 profit for himself.

Despite what his CPA said, the IRS’s position and case law are quite clear that since he drew money out of the corporation and he provided services to the corporation he needs to pay himself a salary.

But what should the salary be? And what if the year has ended and the W-2 deadlines have passed, but the corporate tax return still needs filed?

Here are some options:

ONE: Find legitimate expenses the owner incurred, and call the draws expense reimbursements.

My friend could legitimately document his cell phone usage for business (paid out of personal funds) as well as mileage.  As long as there’s a written reimbursement policy in place, (which — shockingly — my friend DID have), he could legitimately argue that some or all of his draws were reimbursements rather than salary.

Another thing he had going for him: in his articles of incorporation, a resolution was created that specifically said that he would pay the startup costs out of his own funds and the corporation would reimburse him.

In his case, between the startup costs and other reimbursements, he was probably close to the $10,000 mark and could reasonably say his salary that first year was $0.

TWO: File the payroll forms late.

What if there were no reimbursements (or no documentation in place to justify reimbursements)? You could classify some or all of the draws as salary and file the payroll forms late and pay whatever penalties might be assessed. While this is the least desirable, it’s probably the most “right and proper” fix.

THREE: The 1099 route.

One thing I’ve done before — and it’s admittedly not “right and proper” — is to have the owner issue himself a 1099 for some or all of his draws for the year in question, and then get real payroll set up for the current year and going forward. Doing this results in the FICA taxes being paid on the owner’s personal return (in the form of self-employment tax) rather than on the corporate side. Again, not right and proper, but it’s a quick and dirty fix in a pinch.