Those who perform services must be paid a reasonable salary (unless those services are minor).
@Anonymous_ does that mean if one of the members is "not" an employee that their portion of income distribution is taxed at the FICA 15.3% while the member who "is" an employee does not pay the 15.3% on the income distribution but instead only on the portion of their salary?
I am not sure precisely what you are asking.
Regardless, employees (who perform services beyond minor services) must be paid a reasonable salary which would entail W-2 reporting (as well as quarterly withholding and filing, etc.).
I suspect there might be some confusion as to how to proceed here and I would highly recommend that you consult with a local tax professional.
For one thing, it should be made clear that, with an S corporation election, the entity will be filing an 1120-S, not a 1065.
@Anonymous_ What I'm asking is if the following scenario is allowed/possible:
If I'm an employee/member that paid myself a $50K salary I would pay FICA taxes on that amount but not on any income distributions.
If another member is "not" an employee then that person would have to pay FICA taxes on their total income distribution
@pzajic wrote:If I'm an employee/member that paid myself a $50K salary I would pay FICA taxes on that amount but not on any income distributions.
You would be a W-2 employee and the company would withhold those taxes and pay them (quarterly). You would be issued a W-2 for the year in which you performed the services.
@pzajic wrote:If another member is "not" an employee then that person would have to pay FICA taxes on their total income distribution
No, they would not be considered to be an employee if they performed no services (or only minor services) and would not pay FICA tax on a distribution.
@Anonymous_ If not FICA taxes, I'm assuming the "non-employee" member would pay the self-employment tax on the income distribution which is approximately the same amount as the FICA tax?
@pzajic wrote:
...If not FICA taxes, I'm assuming the "non-employee" member would pay the self-employment tax on the income distribution which is approximately the same amount as the FICA tax?
No, because this person is not an employee, the distribution would not be subject to self-employment tax - note that this is not treated the same as a partnership since you made an S corporation election.
Again, you should consult with a local tax professional so that you are clear about how the entire operation functions for federal (and state) income tax purposes. Moreover, you will need to set up a payroll system and maintain it.
@Anonymous_ so having just one employee/member effectively saves all members from having to pay tax on the business income distribution that shows up on their K1 and personal return?
does that mean if one of the members is "not" an employee that their portion of income distribution is taxed at the FICA 15.3% while the member who "is" an employee does not pay the 15.3% on the income distribution but instead only on the portion of their salary?
an S-corp does not generate self-employment income. so as an S-corp none of the owners pay SE tax on the income allocated to them. this is one way S-Corp taxation differs from an LLC/partnership. those that get a salary only pay 7.65 % of their salary for FICA/Medicare. the S-corp pays the other 7.65% for which it gets a tax deduction.
perhaps you should consult a tax pro to get educated on S-Corp operations. the salary payments require filing quarterly Federal 941s and if you have a state income tax withholding state taxes and filing state 941s (or equivalent). there can also be state unemployment taxes and there is a Federal unemployment tax filing - form 940. also it's likely that your state would require the owners who are paid a salary to be covered by workmen's compensation insurance. W-2s and W-3s would need to be filed. the frequency and method of payroll tax deposits are best discussed with the pro. These are just some possible requirements there can be others.
@pzajic wrote:
@Anonymous_ so having just one employee/member effectively saves all members from having to pay tax on the business income distribution that shows up on their K1 and personal return?
Technically, yes, but you really need to understand (again) that this entity does not operate in the same manner as a partnership. There will be additional scrutiny if there is only one employee and the others receive relatively equal distributions from the net profit of business operations.
As @Mike9241 and I stated, you need to consult with a tax professional.
@pzajic wrote:
Thanks to both of you for all of your help!
It's ok to have passive investors who don't take a salary if that's really how the business is run. But anyone who materially participates in the business must have a salary that is fair compensation for their services.
so having just one employee/member effectively saves all members from having to pay tax on the business income distribution that shows up on their K1 and personal return?
NO. NO. NO. they all have to pay income tax on their allocated portion of the business income as shown on the k-1. it's just that this income is not subject to self-employment tax. consult a pro.
@Mike9241 wrote:
so having just one employee/member effectively saves all members from having to pay tax on the business income distribution that shows up on their K1 and personal return?
NO. NO. NO. they all have to pay income tax on their allocated portion of the business income as shown on the k-1. it's just that this income is not subject to self-employment tax. consult a pro.
I believe @pzajic meant to write "...pay self-employment tax..." in that sentence.
@pzajic must be aware that income reported on their K-1s is generally taxable to the other members.