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BillR
11-21-2008, 12:11 PM
I am going to be starting a new S-Corp. I'll be using some money I have in savings plus some more from a buyout.

I think the first year will have very low or negative income - especially in the current climate. So here's my question - am I required to take a W2 salary the first year? I'd rather take no salary and live off my savings which I've already paid taxes on.

vangogh
11-21-2008, 05:46 PM
I did some searching and it looks like you do. Here's an article from About.com on whether or not s-corps must pay salaries to owners (http://taxes.about.com/b/2006/06/16/must-s-corporations-really-pay-salaries-to-the-owners.htm). The article is a couple of years old, but I'd think what's in it still holds true.

Seems like you must pay yourself a 'reasonable' salary. I don't know the exact definition of reasonable, but it sounds like some common sense applies.

Here's an article from the irs.gov sit on wage compensation for s corporation officers (http://www.irs.gov/newsroom/article/0,,id=200293,00.html). Search s-corp at the IRS site or s-corp reasonable salary. There was a fair amount of results, among which is the article above.

Evan
11-21-2008, 07:42 PM
No, you do not need to take a salary during your first year or two of operation if you anticipate having a loss or little net income from which a salary could not be paid from. But as soon as you have some revenues or cash flows to pay yourself a salary, you should immediately do so. No person would ever work for a company for free, per se, but it is not unreasonable as an owner to keep money in the business to grow at the beginning.

Whatever you do though, do not distribute any earnings (commonly called dividends, but are called distributions for an S-Corp) in the initial years even if it's only a "little something" if you're not paying yourself a salary. That tends to raise a red flag.

The IRS isn't as concerned with the "micro" businesses not having paid employment taxes that is keeping the cash to grow. What they are concerned with is companies generating $100K of net income, not paying the officers a reasonable salary (employment taxes), and then avoiding taxes by taking a "distribution".

You should meet with your CPA, accountant, or tax preparer to determine what is reasonable for your specific business.

Good luck!

vangogh
11-21-2008, 11:34 PM
Interesting Evan. I admit my research was about 5 minutes on Google, but it was looking like the salary was a requirement. I was hoping you might come in behind me and sort things out.

OldJack
11-22-2008, 09:36 AM
Interesting Evan. I admit my research was about 5 minutes on Google, but it was looking like the salary was a requirement. I was hoping you might come in behind me and sort things out.

I basically agree with Evan as he has stated it. I disagree with any amount of income that would then require a salary.

It is the taking out of monies, benefits, or property from the corporation to the shareholder that the IRS has the power to "reclassify" as salary. In other words if the shareholder is receiving some form of payments. Note in the IRS article from your link they refer to "distributions and other payments".

To date the IRS has only taken taxpayers to court where they paid zero salary but took distributions from the corporation.

---
Your article link quotes:
>>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."
<<

Evan
11-22-2008, 10:34 AM
Jack -- I was throwing a number out there. If you had $50K of net income and a reasonable salary for that position is $40K, then a salary should be paid. But we also noted, it's a shareholder-employee that distributes cash/property out of the business that raises the red flag.

orion_joel
11-23-2008, 12:44 AM
I think that it would be irresponsible of any government to enact laws that required a business or company to pay a minimum rate to an owner or company officer where it can be determined that the payment would cause the company to have a loss.

Also i totally agree that taking a distribution but no salary should raise a red flag, because it kind of sounds like something is trying to be circumvented.

Business Attorney
11-23-2008, 01:43 AM
I agree with Evan and OldJack and would just add one additional comment. Some S corporation owners try to get around the issue with distributions by taking "loans" from the company instead. I believe that those are no less risky (and perhaps even more risky) than characterizing cash payments as distributions when the owner has not take a reasonable salary.

If you don't take a reasonable salary, you shouldn't plan on taking any assets from the corporation, no matter what you call the transaction.

vangogh
11-24-2008, 12:06 AM
Thanks Evan, Jack, and David. I'll be the first to admit I'm hardly an expert on this issue, but after doing a little research I was coming to the opposite conclusion of what you're all saying. It shows how sometimes research is no substitute for contacting an expert. Thanks for helping to clear things up.

Evan
11-24-2008, 12:14 AM
There are often exceptions to the rules, and this is one of them. But otherwise, and generally speaking, a reasonably salary is needed.

BillR
11-24-2008, 12:51 AM
So it's safe to say that if I make little profit in the first few months I can just live off savings and then when the first measurable positive cashflow happens I should start with a small salary and expand accordingly?

Yes - I will check with a CPA - but I'm just ball parking a few things for now.

Business Attorney
11-24-2008, 09:07 AM
So it's safe to say that if I make little profit in the first few months I can just live off savings and then when the first measurable positive cashflow happens I should start with a small salary and expand accordingly?

Yes, that is correct.

OldJack
11-24-2008, 06:22 PM
I should also point out in this discussion that if a shareholder does not perticipate in the operation of the S-corp then there is no requirement in taking a salary for that shareholder. In other words if the shareholder is simply an investor. On IRS audit the first thing the auditor asks (on this issue) is how many hours a year does the shareholder participate.

BillR
11-25-2008, 12:11 PM
Okay, I know I'm beating this to death but...

I expect to make a fair amount of money in the first 1-2 months of existence. This is simply because I am going to finish up a consulting contract. I'll also be kicking in cash in the beginning to get the ball rolling.

After that I anticipate spending a fair amount of money getting various things in the business up and running. So I do not expect a net gain in the first 6 months.

How would you handle that?

Evan
11-25-2008, 03:12 PM
"Fair" is very subjective.