The number one IRS audit risk for S Corporations is salary and wages paid to officers of the corporation.

This is probably the most important letter I will write to you this year.  There is no doubt that you, as an S Corporation owner have made very good tax move.  The popularity of  S Corporations is growing each year.  More than six million S Corporation returns will be filed this year.  They offer more advantages than any other choice of business entity today.  You have chosen wisely.

However, there is one rather large S Corporation pitfall that I am required by IRS Circular 230 to warn you about.  

The number one IRS audit risk for S Corporations is salary and wages paid to officers of the corporation.

Here is what the IRS says about wages and salary paid to officers of Subchapter S Corporations:

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.

Although this IRS interpretation of reasonable salary just recently updated in October 2011,  is somewhat arbitrary, it is extremely important not to overlook paying yourself a salary before the end of the year.  

What should you do? Don’t panic.Call us.  We can help. There is still time to fix any oversights.

Remember what Ben Franklin said an ounce of prevention is worth a pound of cure.  He also said that there are only two certain things in life:  death and taxes.