I think the article explains things very well.
There are essentially two ways a S-Corp owner might receive cash from the company:
1) A wage or salary reported on Form W-2. This income is subject to - naturally - income taxes and FICA. And, as the article points out, the IRS expects that an S-Corp owner will take a reasonable salary.
2)Distributions from the business to the owner, reported as Shareholder Distributions. These distributions are treated, in effect, as a "return of capital" and serves to reduce the shareholder's investment in the business. Since this cash is "return of capital" it's not "income" and it's not subject to income tax or FICA or SE Tax.
It's easy to see that you'd want to maximize #2 and minimize #1, but of course the IRS knows this too, hence their position that failure to take a reasonable wage "can be considered a crime of tax evasion"
The S-corp structure is a "pass through" entity, meaning that the corporation pays no income taxes in its own name. Instead the corporation's profit and financial activity is "passed through" to shareholders in proportion to their ownership. Of course the corporation's profit is calculated after salary/wages and FICA paid to its employees, including your wife.
To (overly) simplify, your wife has two sources of income from her S-corp: Her wage or salary and the corporation's profit. Distributions of cash characterized as shareholder distributions are not income and, accordingly, are not reported as such.
Tom Young
