These federal caseshave now been the backbone or blueprint to these issue regarding compensationsas wages. A shareholder who provides major services should be considered asemployees and receive wages. When reaching a reasonable wage, it should beanalyze by several factors such as what type of business, duties andresponsibilities and how much time is devoted to the business.

Even if it isnot your intent to avoid paying payroll taxes, you must follow rules of the taxcode.                                            Inthese cases above, the S corporation had not reported any compensation.However, in the case of DAVID E. WATSON, P.C. v.

U.S., there was some sort ofwages paid but there was three times as much distributions being paid as well.Therefore is the compensation reasonable, which is what the court had to figureout. There was no debate that the shareholder officer was an employee. DavidWatson was an accountant who was the sole shareholder director, officer andemployee of an s-corporation.

He was 25 % partner in an accounting firm thatpaid him an annual salary of $24,000. Along with his annual compensation, theaccounting firm made large profits of $24,000 and gave David Watsondistributions of $203,651 in 2002 and $175,470 in 2003. There was no income taxwithheld from these dividends. Therefore, the district court was forced toquantify what is a reasonable compensation for Watson. So the IRS engaged theservices of a general engineer who used financial ratios to establish whetherhis compensation was reasonable or unreasonable.

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As of result, the court upheldthe district court of an annual compensation of $93,000 from the distributionshe earned each year.                            In the case of Jolyvs. Commissioner, 211 F.

3d 1269 (6th Cir., 2000), the court ruled him anemployee to the corporation.  “Tax courtfound that these calculations were based on the corporation’s bank statements,which indicated that regular payments were made to and on behalf of Joly” (Jolyvs.

Commissioner, 211 F.3d 1269 (6th Cir., 2000)). He was activelyparticipating in the overall services in the business which leads the court tohold him accountable for employment taxes not paid. Another case, that helpsjustify whether payments should be classified as wages and not asdistributions. In reference to code section U.

S. Code § 1368 – Distributions,it is defined as ” A distribution of property made by an S corporation withrespect to its stock to which (but for this subsection) section 301(c) wouldapply shall be treated in the manner provided in subsection (b) or (c),whichever applies.” In this case, Joseph M. Grey Public Accountant, P.C. vs.Commissioner, 119 T.C.

121 (2002), the accountant was taking dividends andinstead of paychecks as an employee. When taking dividends this only affectstheir basis in the s corporation and thus are not taxed as wages avoid payingsocial security and Medicare tax.                                  In referenceto SPICER ACCOUNTING, INC., Plaintiff, v. UNITED STATES OF AMERICA, defendant wasan accounting firm that paid dividends but no compensation who providedservices to the corporation. SAI was owned by a Spicer who was a CPA and hisspouse and he worked approximately 36 hours per week.

He was the onlyaccountant for his company. He would withdraw his earnings as distributions.Therefore, he never paid payroll taxes on the amounts received. The ninthCircuit look closely into what represented these distributions that were beingpaid to him. So first they looked into what defines an employee for payroll taxpurposes, which include any officer of a corporation.

However, as we discussedearly, it depends if there was major or minor services provided to thecorporation. Since he was the only accountant in his firm, he was the only oneable to provided tax return and audit services to clients. The ninth circuitconcluded that the distributions that were withdraw for Spicer was indeedcompensation and should be subjected to payroll taxes. Spicer, a full timeworker cannot avoid paying payroll tax or self-employment tax just because hecreated an S corp. The correct method was to create a sole proprietor orsingle-member LLC and pay self-employment tax if he was trying to avoid payingpayroll tax.                                   Now that weunderstand what an S Corporation status represents and its purpose. Canshareholders such as a corporate officer receive a w-2 and schedule k from thesame business.

As a shareholder of an S Corporation, at the end of the taxyear, schedule k reporting the gross profit/ loss of the company will be sentto each shareholder. However, if that shareholder perform a service for thecorporation and receive payments, those payments are considered wages accordingto the internal revenue code. It doesn’t matter if it’s a corporate officer,they are still considered an employee.

There have been cases where courts haveheld S corp officers/ shareholders who provide more than minor services totheir corporation and receive compensation are subject to federal employmenttaxes. However if they provide only minor services, is not considered anemployee. Therefore, in some cases companies have tried to pay a reasonableamount of wage to corporate officer but take a large amount of distributions.Shareholder-employees wants to minimize compensation in favor of distributionsto reduce payroll taxes. Since employment tax obligation have risen, theadvantages in operating as an S-Corporation has been looked into closely. Scorp income are not subject to self-employment tax, more officers are in favorto minimize salary and take distributions to avoid paying payroll tax norself-employment tax.                      Can a shareholder of anS-Corporation receive a w-2 and schedule-K? Before we answer this question, wemust take a few steps back and analyze an S-Corporation entirely.S-Corporations is what we call a flow through entity.

The reason we call this aflow through entity because they pass corporate income, loss, deductions, andcredits through to their shareholders for federal tax purposes. Therefore, theshareholders report income, loss, deductions and credits on their personalincome tax return and are assessed tax on their individual income tax rates.Many investors are more subjected to elect into an S-corporation because itavoids the hassle of a double taxation. What is double taxation? It simpleterms, it is paying tax twice for the same income. Business owners often try toavoid paying tax, but paying tax twice just seems unfair. For example, a Corp istaxed as its own entity.

Profits are taxed at corporate income tax rates. Thereis no problem with this. However, when a shareholder are paid dividends, thesedividends are taxed at a personal income tax rate. Therefore many smallbusinesses elect to change an S Corp status with the IRS, to avoid this doubletaxation. Achieving S corporation status, a corporation must first qualify as asmall business corporation and met a few requirements that include if it’s adomestic corporation, is an eligible corporation, issues only one class ofstock, limited to maximum of 100 shareholders, and has no nonresident alienshareholders.

Once achieved S corporation status, small business owners cantake advantage of the benefits for federal tax purposes. S corporations are known to havetax advantage and benefits when it comes to filing taxes. This is the result ofmany small business electing to switch to an S corporation. Although, somecorporate officers can run into small problems when it comes to payments madeto themselves. Often time’s shareholders have agreements within the Corporationthat state their share will be the profits of the company.

However, if youprovide major services to the corporation, these payments are most often timeconsidered wages. Base of a few federal court cases, we will see how these canbe justified and how IRS acts toward this misconception of payments.