Income Taxes for a Bonus

But the corp is required to pay a reasonable salary, so a distribution can be reclassified that way.

Seth

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Hello Katie,

Thanks for the reply. Bob made over $100K salary during both 2006 and

2007 and will be making over $100K during 2008 as well. I assume this is enough to facilitate the $210K being paid as a distribution.

Raffi

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On Jun 9, 7:59 pm, snipped-for-privacy@gmail.com wrote:>

Then I think you are OK, assuming $100,000 is reasonable compensation for what he does for the corporation.

Katie in San Diego

How does one determine reasonable compensation?

The instructions for 1120-S say that if it was previously taxed income (then it can be distributed). I don't know if this means that it cannot be recharacterized, but certainly hope it cannot be recharacterized. See

Column (c). Shareholders' Undistributed Taxable Income Previously Taxed

The shareholders' undistributed taxable income previously taxed account, also called previously taxed income (PTI), is maintained only if the corporation had a balance in this account at the start of its

2007 tax year. If there is a beginning balance for the 2007 tax year, no adjustments are made to the account except to reduce the account for distributions made under section 1375(d) (as in effect before the enactment of the Subchapter S Revision Act of 1982). See Distributions below for the order of distributions from the account.

Each shareholder's right to nontaxable distributions from PTI is personal and cannot be transferred to another person. The corporation is required to keep records of each shareholder's net share of PTI.

Distributions General rule. Unless the corporation makes one of the elections described below, property distributions (including cash) are applied in the following order (to reduce accounts of the S ...

By comparison to others doing similar jobs in similar industries, when others than themselves determine the amount paid.

Stu

It _can_ always be recharacterized if challenged and taxpayer loses the contest over whether adequate compensation was paid.

With great difficulty .

Actually this is one of those somewhat amorphous, subjective, "facts and circumstances" things. As Stu suggests, comparables in the corporation's industry are an important benchmark. What would I have to pay an employee with qualifications similar to mine to do what I do? What could I earn as salary if I did it as someone else's employee? How does the corporation earn its income -- is it all as a result of my personal services (e.g., a consulting business), or does some of its income arise from the services of others (e.g. employees or independent contractors) or from the use of the corporation's property or the sale of merchandise? And so on.

If the taxpayer can show a revenue agent a good-faith, documented analysis whereby the compensation level was calculated, it is likely to pass muster. No guarantees, though.

Katie in San Diego

I once had a client who took home more than $400,000 from his company in one year, and the IRS wanted to impose an additional tax of $100,000 as a result of a deemed dividend. I was able to show that he built the business up from almost nothing, that in prior years he had taken a very low salary, and that the additional amount that year was in the nature of a bonus for the sacrifices he had made in prior years.

The IRS (eventually) backed off completely and didn't get a single dollar.

Stu

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Well, this is the difference between THEN and NOW. THEN we were worried about EXCESSIVE compensation paid by C corporations. NOW we are worried about INSUFFICIENT compensation paid by S corporations.

It's also the difference between C and S. To the extent that a C corporation treats amounts paid to its stockholder/employees as wages, the corporation gets a deduction. If the compensation is deemed excessive, part of it may be reclassified as a dividend. Makes no difference to the individual, but the corporation gets no deduction for the dividend. So the $100K would have been assessed at the corporate level.

S corporation planning goes the other way. If cash withdrawn is treated as wages, it is subject to Social Security and Medicare taxes, and the corporation must pay for workers' compensation and unemployment insurance. If it's a distribution of income on which the stockholder/employee already has or will have paid income tax, the payroll taxes don't apply. So in the S corporation case the IRS is looking to reclassify distributions as wages, rather than the other way around.

Katie in San Diego