I read an interesting story in the Journal of Accountancy (well interesting to me, a CPA!) about an owner of an S corporation that serves as a warning to all of you considering S corporation status for your business.
(Here’s a link to the article “Eighth Circuit agrees that CPA was underpaid” if you care to read the details, but is it loaded with accounting-ese)
In summary, a CPA formed a S corp with himself as the sole owner, shareholder, director, and employee. He was paid a salary of $24,000 and took the rest of the S corp’s profits as dividends of $203,651 in 2002.
The IRS requires S corp owners to take a “reasonable” salary and pay Social Security (FICA) taxes on that salary. Dividends are not subject to FICA tax. By calling his profits dividends instead of salary, the CPA didn’t pay FICA tax on $203,651!
The IRS determined a “reasonable salary for this full time CPA with 20 years experience was closer to $90,000 a year, not $24,000 and charged him the FICA taxes on the difference as well as interest and penalties.
As a CPA he should have known better! Really!
This is one of the problems with S corp status. You must still take a reasonable salary for services you provide to the corporation. If you try and take a low salary to avoid paying FICA, you may find yourself in tax court like this guy.
How to know of corporation status is a good idea for your business? Read Chapter 5 Corporations in Business Tips and Taxes for Writers. Order a copy here. Or schedule a phone consultation with me and we can discuss your options. Contact me here.
Carol Topp, CPA