S Corporations
If you've done much research on the subject of S corporations, you've probably already learned that S corporations may allow shareholder employees to save significant amounts of payroll tax.
Even small S corporations can save significant sums by carefully setting shareholder-employee salary levels. For example, a sole proprietor who earns $90,000 might save roughly $6,000 annually if he or she can fairly break the $90,000 into $50,000 of owners salary and $40,000 of "dividends."
The trick in making this tax planning gambit work, however, is in setting a reasonable compensation level. On one hand, you cannot set the salary level to $0 even though would mean you don't pay any payroll taxes. (Many businesses and CPAs have learned this lesson the hard way, unfortunately. In the last few years, the IRS has begun to aggressively challenge low salaries to S corporation shareholder-employees.)
On the other hand, you should be able to set a salary that's equivalent to what the S corporation might pay some other non-owner employee to do the job that the shareholder employee does. For this reason, one of the most important things you can do to buttress your shareholder-employee compensation policy is to collect good data about what other companies like yours pay people to do a job like the shareholder-employee does.
If you're concerned that your S corporation shareholder- employee salaries might be too low, let me conclude by making a couple of comments:
1. If you're working from a solid job description, I believe that you can argue a shareholder-employee's salary is reasonable if the salary is between the 25th and 75th percentiles for a particular job. In other words, in my mind, "reasonable" doesn't mean the median salary or an above average salary. (Think about this a minute: It seems very difficult to argue that if a quarter of the people doing a particular job are getting paid less than the shareholder-employee that the shareholder-employee is being under-compensated.)
2. If you're a client and you're concerned about the risks of a low salary, we should discuss this issue next time we work together.