If I take no distributions from an S-Corp, do I need to be page wages?

[jj_schoolshop]

If I took no distributions from a 100% owned S-Corp, do I need to pay myself wages?  The S Corp started 6 months ago and earned about $50K last year.  I didn't set up payroll and am wondering if not paying myself wages last year is ok, so long as I haven't taken any distribution.  If I start payroll this year, and the wages for this year is MORE than the S Corp earns THIS year but LESS than the total cash the S Corp has (accumulated from last year), will I be paying federal income tax again on the W-2 income from the S-Corp (even though I paid the income tax on the S-Corp income last year since it was passed through to me as the shareholder last year)?

Or is there no such concept as not taking a distribution in a S-Corp since it is all pass through and I am paying income tax on the net income whether or not there is a distribution from the S-Corp.  (in which case I may be in trouble since I did not do payroll in 2016).

[ChrisV]

You do not necessarily need to pay yourself wages or take a distribution, but you may opt to do one or both. Assuming that all the income is from this year, it is all treated as ordinary income in fiscal 2016. If you do not take a distribution or wages, the remaining profit is considered "pass through" income and is ordinary income on your personal return.

For next year's situation: assuming that you have the profit from fiscal 2016 minus the tax liability available, this is considered "retained earnings". You may draw from this as the 100% owner of the company without declaring it as income or paying taxes on it as it has already been taxed.

Please note, if you pay wages higher than the income for the year, this may result in a business loss. If you want to draw from prior years retained earnings after your wages equal income for the year (as to not take a loss), this would be taken as a retained earnings distribution and not through your payroll process.

[ThomasR]

TurboTaxChrisV: why are you saying you do not have to pay yourself a salary nor pay out distributions.  I agree that you do not have to take distributions, but as an active S corporation owner, you MUST pay yourself a reasonable wage or salary based on a number of factors.  Take a look at the S corporation acceptance letter.  It now states (as it has for several years) that an owner is required to be paid a reasonable salary.   The IRS does not define "reasonable compensation".  However, tax court cases have given a pretty good idea of what the IRS and the courts look at in determining the owner's salary.  I have represented clients before the IRS on "reasonable compensation" payroll audits.  (The only issue under the audit was whether or not the S corporation owner received a reasonable wage or salary.)  The auditor always looked at the type of work being done and what someone is such a position were paid in the area in which the taxpayer conducts business.  While there are many factors they look at, it is clear that a reasonable wage or salary is absolutely required.  

[Rick19744]

I agree with @ThomasR.  This is a hot item for the IRS and an active shareholder who is not being paid wages is likely to win the audit lottery at some point.

If this was an initial year and no distributions were made, the IRS would most likely not push the issue.  You would most likely just claim that since this is the initial year you needed to get an idea of cash flow before starting to take a wage.

Since you appear to be profitable, make sure you get on the payroll for 2019; especially since we are 6 months into the year.  You could have some exposure for the past years but just get it corrected ASAP.

You should meet with a tax professional so you understand how S corps work; pass-through entity and all income is taxed at the shareholder level regardless of whether distributions were made.

@ChrisV is not technically correct on a number of items; first as noted above, an S corporation shareholder that is active should be taking a wage.  Second, an S corp technically tracks their AAA not retained earnings.

When you prepare the S corp return, you will need to maintain what is know as the accumulated adjustments account (AAA).  This needs to be maintained along with your basis in the S corp.

As long as you have positive AAA and basis, any distributions will not be taxable since the shareholder has already paid tax on these earnings.

You will also need to understand fringe benefits as the tax implications are not the same as a regular C corporation.

Attached is a link to provide some guidance on maintaining your basis in the S corporation:

https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-stock-and-debt-basis

[Rick19744]

@ChrisV are you a TT employee?