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.)
The
fastest way to get audited as an S-Corporation is to not report wages to
officers on page 1 of the return.
If this is something new to you I HIGHLY suggest you seek a local professional to get educated and get your books & payroll set up correctly ... making a mistake in these areas can cost you a lot later in penalties.
