With year end approaching I would like to remind owners of S-Corporations who own more than 2% of their outstanding stock about issues relating to medical and dental premiums that the company has paid on their behalf and a related issue of reasonable wages for a S-Corporation owner who is active in the management of the business. Please see attachment for details about each subject.
Recently, our staff have heard from a couple of reliable sources that IRS agents in the field are using 60% to 65% of net income before owner compensation as a guide to determine what “reasonable” wages are for more than 2% stockholders of a S-Corporation and who are “active” in the business. For example, if a S-Corporation business has net income (revenue less expenses) before compensation to owners of $100,000, that means that the IRS will expect the owners to take a salary of at least $60,000 to be considered reasonable. This would obviously result in net income after owner compensation of $40,000 ($100,000 less $60,000).
If the IRS determines that you have not met at least the 60% reasonable test limit, then the IRS may reclassify some of your dividends (owner draws) to wages and make you pay back payroll taxes plus penalties and interest.
With regard to the medical and dental premiums paid by the S-Corporation, please be sure to remind your payroll service that you need your last paycheck of the year “grossed up” by the amount of the yearly premiums in order to benefit from the full deduction of these premiums. If you prepare your own payroll and we prepare your quarterly and year end payroll returns and W-2s, we will contact you to ensure that we have the correct figures to gross up your final paycheck.
If you would like more detailed information on this topic please download the document below.
Dean R. Holland, CPA