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#17
TM,

Yes, we have been over this before...but I feel that the way that you explain it is extremely confusing for laypeople.
I respect your opinion that you think it is confusing, though I have given the same explanation I gave above to many clients and have not had any say it was confusing, let alone "extremely confusing." The line that some sites (and unfortunately even some tax pros) give out that a S-corporation must pay a salary is simply wrong. Sure, it's a simple, easy to understand statement, but when a simple statement is actually wrong then it should not be used. Better that someone be confused and ask for clarification than walk away with a simple but wrong answer.
 

LdiJ

Senior Member
#18
I respect your opinion that you think it is confusing, though I have given the same explanation I gave above to many clients and have not had any say it was confusing, let alone "extremely confusing." The line that some sites (and unfortunately even some tax pros) give out that a S-corporation must pay a salary is simply wrong. Sure, it's a simple, easy to understand statement, but when a simple statement is actually wrong then it should not be used. Better that someone be confused and ask for clarification than walk away with a simple but wrong answer.
A lot of them won't ask for clarification. They will just see you saying that they don't have to pay a wage and run with it. In my entire career you are the only person I have ever seen that explains it the way that you do. I perfectly understand your explanation and cannot fault it. My professor in graduate school didn't explain it the way that you do, and no speaker at any professional conference or CE has every explained it the way that you do either. It doesn't get explained that way in the annual IRS seminars either.

Literally everybody else says that an S-corp has to pay a reasonable wage to working shareholders...and that reasonable wage takes into consideration actual profits as well as fair market value.
 
#19
A lot of them won't ask for clarification. They will just see you saying that they don't have to pay a wage and run with it.
If that's what they do then they ignore the rest of what I tell them. That's on them. My clients so far have not made that mistake.

Literally everybody else says that an S-corp has to pay a reasonable wage to working shareholders....
No, literally everyone else does not say that. That statment of the law is wrong, and not everyone gets it wrong. I am not the only one that has stated the rule as I have, though I may be the only one you have heard say it. :p

I have quoted here before the tax court cases that set the reasonable compensation rule, and it is those cases that set the basis for my explanation of the rule. And internal IRS training that I attended or participated in explained it the same way I did, too. In an information letter issued to a taxpayer, the IRS explains it that way too:

Generally, under the rules described above, if a shareholder of an S corporation performs services for the corporation, any distribution to the shareholder, even if legally declared under state law by the S corporation as a dividend, will be characterized as “wages” subject to employment taxes where in reality the payments are for services. An S corporation cannot avoid employment taxes merely by paying the corporate shareholder “dividends” in lieu of reasonable compensation for services performed.

And this from an IRS press release:

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.”

The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. However, if cash or property or the right to receive cash and property did go the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate.

There are no specific guidelines for reasonable compensation in the Code or the Regulations. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of each case.

WAGE COMPENSATION FOR S CORPORATION OFFICERS, 2008 WL 4945387, at *1 (italics added). Note in particular that the IRS says that the amount of compensation never exceeds the amount that the shareholder actually got from the corporation.

Info. Letter, IRS INFO 2003-0026 (Mar. 31, 2003). The Congress Joint Committee on Taxation (JCT) also puts the rule the same way:

In cases addressing whether payments to an S corporation shareholder were wages for services or were corporate distributions, courts have recharacterized a portion of corporate distributions as wages if the shareholder performing services did not include any amount as wages.

JCS- 2-14 NO 16 (FTX BLUEBOOKS), PART XV - LOOPHOLE CLOSERS, 2014 WL 7342582.

So it is not the case that "Literally everybody else says that an S-corp has to pay a reasonable wage to working shareholders." Notably the JCT, IRS and courts have NOT said that. That is not the rule despite how often I see web sites, some practictioner handbooks, and some tax pros make the statement that a wage must be paid. It is simply not the law. What I think happened is that tax lawyers were advising clients that they should pay a wage or salary each year (and often still do as it makes sense for many clients) because that will tend to keep the tax bite lower and that others upon hearing that took it to mean that a salary or wage must be paid, and that statement then got repeated over and over to other practitioners to the point that many now believe it is true. That's because most non lawyer tax practitioners do not extensively study the actual code, regulations, case law, etc. That is too time consuming and for their purposes unnecessary. They can do what they need to do relying tax treatises or other aids. I don't fault them for that in the least. It is simply more efficient to work that way for their work. But I don't rely on treatises. I am a lawyer and used to be a lawyer at IRS. Lawyers at IRS in particular do not rely on treatises. They research the actual law. The same with lawyers at the JCT and of course federal judges. That is why you do not see any of them making that same mistake of stating a wage or salary must be paid.

The rule may be simply stated. A S-corporation does not have to pay anything to its shareholder. It can retain all its earnings to expand its business, invest, or whatever. But at the point that the S-corporation does distribute any money or property to the shareholder in any form — whether the corporation calls it dividends or whatever — that will have to first be treated as wages at to the shareholder at reasonable compensation for all the work he or she has ever done for the corporation and for which he or she has not yet been paid. In short the rule does not say the corporation has to give the shareholder anything. But at the point the corporation actually does make a distribution, the rule tells you how to treat that distribution. I don't see that as particularly complex or difficult for most people to understand. I don't think that is very confusing. I think it bothers and maybe confuses some tax pros — and perhaps you among them — because it conflicts with what they learned and long thought was the rule. It is unsettling, understanably, to find out that what you thought was true for a long time actually was not true at all.
 
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