S cor­po­ra­tions and taxes

Austin American-Statesman Sunday - - MONEY & MARKETS EXTRA - By Joyce M. Rosen­berg

Many small busi­ness own­ers struc­ture their com­pa­nies as S cor­po­ra­tions, a setup that can lower their tax bills and al­low them to pro­tect their per­sonal as­sets if the com­pany is sued. But own­ers who try to lower their taxes too much can run into trou­ble with the gov­ern­ment.

S cor­po­ra­tion own­ers typ­i­cally draw a salary from their com­pa­nies and also take a div­i­dend dis­tri­bu­tion. Prob­lems can arise when own­ers try to save on what are called pay­roll taxes — So­cial Se­cu­rity and Medi­care with­hold­ings — by pay­ing them­selves an un­rea­son­ably low salary and pump­ing up their div­i­dends. The lower their salary, the lower their pay­roll taxes will be.

Tax pro­fes­sion­als say un­rea­son­ably low salaries at an S cor­po­ra­tion are a red flag to the IRS and could prompt the gov­ern­ment to au­dit an owner’s re­turn — and in the case of mul­ti­ple own­ers, their re­turns as well. If the IRS deems salaries to be too low, it can re­clas­sify div­i­dends as salaries and own­ers can be forced to pay back taxes, in­ter­est and penal­ties.

The IRS web­site, www.irs.gov, lists sev­eral fac­tors that courts have con­sid­ered in de­ter­min­ing whether a salary is rea­son­able. Among them: an owner’s train­ing and ex­pe­ri­ence, du­ties and re­spon­si­bil­i­ties and time de­voted to the busi­ness. Also, the com­pen­sa­tion given to em­ploy­ees who are not share­hold­ers, and the salaries that com­pa­ra­ble busi­nesses pay for sim­i­lar ser­vices.

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