IRS looking at S corp officer pay

IRS 'Fact Sheet' on S corporation compensation and health insuranceThe IRS has issued a Fact Sheet (FS-2008-25) on salary requirements for S corporation officers. The main point of the Fact Sheet is that corporate officers are required to take a "reasonable" salary out of the S corporation. The IRS doesn't like it when S corporation owners don't take a salary; S corporation income that passes through on a K-1 instead of a W-2 isn't subject to FICA and Medicare tax, so S shareholders are tempted to take little or no salary to avoid the 15.3% combined employer and employee tax hit.However, the tax law isn't clear on how much salary you need to take to avoid IRS trouble, and there is little IRS guidance on the matter .

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: Training and experience, Duties and responsibilities, Time and effort devoted to the business, Dividend history, Payments to non-shareholder employees, Timing and manner of paying bonuses to key people, What comparable businesses pay for similar services, Compensation agreements, The use of a formula to determine compensation S corporation shareholder medical insurance. etc...

The fact sheet also addresses S corporation owner health insurance: 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-employees 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.The shareholder can then deduct these amounts on Line 29, page 1, Form 1040.

The Fact Sheet refers to Notice 2008-1, the detailed IRS guidance on reporting S corporation owner health insurance, and it addresses a question posed to us by several commenters: 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.So as you head into the final paychecks of the year, be sure your S corporation shareholders have their health insurance as a taxable benefit (but not for FICA and Medicare) on their paystubs before year-end so the W-2s come out right.