2022 Planning - Payroll vs Distribution Split & Taxes

[tschapira]

Hi TurboTax Experts, 

I'm an independent consultant and trying to determine what my 2022 payroll vs distribution should be, including any extra Fed/State withholdings. My firm is a single member LLC with S-Corp filing status.  Let's assume my monthly income is $12,500 or $150,000 year.  

• I'm planning a 35% salary ($52K), 65% distribution ($97,500) split. Is this acceptable? 
• Included in my 35% salary, I have 24% for Fed Withholding, 4.95% for state withholding, 6.2% for SS and 1.45% for MC. Is this correct?
• In my 65% distribution, do I need do extra withholdings for self-employment tax of 15.3% or is this tax free? I'm confused about this and need your guidance. Will I be paying taxes on this earnings at year-end?
• Not included, which I need to budget for is the employer payroll tax 6.2% SS and 1.56% MC. Is that correct?

Thanks for your guidance!! 🙏

Tom

@Anonymous_  @Critter-3 @VolvoGirl @Carl 

[M-MTax]

I'd say.....as one opinion.....that a salary of 35% of the total profit for this biz is kind of on the short side. If you get audited that could change real fast.

AND you don't need to pay SE tax on anything like distros or business income......you're an employee of the corp and get a W-2. 

[tschapira]

Thanks @M-MTax  - what % won't raise a flag? Also, are my assumptions on tax rates correct?

[M-MTax]

The other stuff looks fine BUT the percent W/H for your state I have no idea....don't know which state. The fed W/H depends on your total income....is it enough? Run the numbers to see if you're paying in enough.

The % that won't raise a red flag depends on the type of biz and you involvement.....the services you render and your expertise. I'd say for an ALL SERVICES biz where you run the entire show and do all the work not to go anywhere below 50% and even that's pushing it. If it were me I'd stick to around 75% as a salary for a biz where I provided all of the services. You're pretty much safe there.

[Rick19744]

A few comments:

• I agree with @M-MTax in that I believe your ratio of salary to distributions would most likely not pass an IRS exam.
• We can't provide too much more guidance since this is an area that is based on many factors, of which we don't have, and really this forum is not conducive for working through this type of question.
• In my mind your ratio should at a minimum be reversed, especially if you are the sole driver of the business.
• Also keep in mind, that this is a hot topic for the IRS.

[Critter-3]

A lot depends on many factors ... if you are the ONLY employee and you don't subcontract out a lot of the work then I agree taking less than maybe 75% would be risky if you are audited.  You can base your salary on what the going salaries in your area are for the same work you do.   For instance if you are a plumber and plumbers in your area make $50 an hour then a salary of $2000 a week would be reasonable with the rest as a draw.  

The IRS position is that an S-Corporation MUST pay a reasonable compensation to an officer before non-wage distributions may be made.  The reason is that they feel that non-wage distributions when no wages are paid is an avoidance of social security taxes.  From the IRS website at http://www.irs.gov/businesses/small/article/0,,id=203100,00.html :

"Reasonable Compensation

S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.

Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for the service rendered to the corporation.

Several court cases support the authority of the IRS to reclassify other forms of payments to a shareholder-employee as a wage expense and subject to employment taxes."

The page cites Joly vs. Commissioner, 211 F.3d 1269 (6th Cir., 2000) as one judicial finding on the IRS's authority to reclassify distributions to wages subject to employment taxes.  Factors to determine reasonable compensation are given in the ruling.

The AICPA has an interesting article on this topic here: http://www.aicpa.org/publications/taxadviser/2011/august/pages/nitti_aug2011.aspx

You also might want to read a lively discussion on the Tax Almanac website here: http://www.taxalmanac.org/index.php/Discussion_Forum_-_Tax_Questions .  The substance of the discussion seems to be that taking a reasonable salary is not optional and, if you took distributions with no salary, the distributions should be changed to salary with appropriate employment tax returns being filed (late, if necessary.)