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A partner and I set up an S-corp this summer to save on some self-employment taxes. We are planning on paying ourselves 50% salary and 50% dividends. The salary part I have figured out with all of the payroll taxes etc. But now we are ready to declare a dividend and I'm unsure of how to proceed.

Anyone have some experience with this? We will write checks to ourselves from our corporate checking account, but how do we make the dividend official (for tax purposes). Is it sufficient to put it in the corporate minutes?

TIA

I have done this over ten years or so. It is really more of a case of matching up all your records so that you can figure out what you did years from now. It can be quite simple. The idea is to yes, declare the dividend so that an audit would reveal a documented procedure. Then, to write the dividend checks to the shareholders in proportion to their percentage of ownership of corporate shares. Then at year end to have the S-corp. properly issue the 1120? report to each shareholder (I forgot exactly the form's name). This form shows at least the amount of interest delivered to each shareholder by the S-corp, and also the amount of dividend distributed to each. Then of course each shareholder properly records on their 1040 filing the amounts shown on that report (in my case this is shown on Schedule E). The end result is that, regardless of how small the S-corp is, the documentation is excellent and just as valid to an auditor as all the better looking forms that a larger S-corp with hired accountants might generate.

The above withstood one audit. Nothing about the S-corp or these distributions triggered the audit, they told me, but I had failed to show that any officer had received remuneration. They agreed that I (that officer as president) had received pay as salary, but that was on a separate line of Form 1120S. The auditor explained that nobody thinks that an officer is going to officiate without pay, so it looks funny and hence the audit. Since then all my salary has gone on that officer remuneration line and none on the salary's line, and never an audit since.

Good luck to you.

i read that if you are a one or two man corporation, giving yourself no salary and dividend only will get you in trouble w/ the irs.

Penguinator,

Your experience is extremely valuable - Your PM's are off or I'd ask directly - I have a specific question for you.

I'm looking at the following form: Form 1120S

I can't find the line where I put the dividends paid to the shareholders. Can you point me in the right direction?

As far as I understand if we're paying half of the income to the corporate officers and the rest we're distributing to the shareholders (which are the same in this case) the corporation shouldn't owe any income tax whatsoever? (besides the payroll taxes). Is this the case?

Oh and mshen, yeah I guess the rule is you have to pay yourself a "reasonable salary." We figured that 50% salary would be reasonable in our eyes.

In an s corp all profit and tax liability passes through to shareholders.

Yeah I understand that, I guess I'm just confused on how that passes through - we're going to distribute all profits, and essentially the corp will have zero assets.

The salary is easy enough to pass on individually, we issue w-2's to ourselves and account for it on personal taxes... but the distributions are the problem for me.

"reasonable salary."

From what I understand is around 18-20k anything under raises flags as under compensation.

Draws or dividends income goes on your K-1 form when you file your fed taxes

Edit K-1 is like a 1099 s-corp files it with its year end you also file it with your personal taxes

Link for K-1 IRS Form

Ok so how do I document that the money went out?

So to recap:

I write myself and my partner a check for the cash distributions, record the transaction in the corporate minutes? (do I declare a dividend?) and then at the end of the year I issue a k-1 form to myself and the partner? Am I missing anything?

You got it is very simple. The K-1 is included with the s corps return

I would also highly recommend you get a CPA to make sure your books are in order it will drop your audit risk <img src="i/expressions/face-icon-small-smile.gif"border=0>

The IRS will be attacking reasonable compensation issues.

If last year you took $60,000 in compensation from the corporation. How do you explain why this year you took $20,000 as compensation and $40,000 as S-Corp dividends if revenues and the net profit is the same for both years?

You can't. The IRS will say the entire $60,000 is compensation and you owe additional taxes, interest and penalties. Build your arguements today for use in the future audits.

The corp is new this year, so there's no history. We're going to do this from the onset, for the exact reason you mentioned above.

buy turbo tax business. it includes 1120s and k-1

Pay yourself $0.00 in salary. Many big company CEOs have done this and the IRS didn't jail them. If you get audited, tell them you believe in getting paid for performance, not getting paid for showing up. Any S-corp profit you earn has to be distributed and taxed anyway, so you're not doing anything illegal or unethical. The flip side is you're not paying FICA taxes, and when it comes time to retire or become disabled, your Social Security benefit is smaller.

<<Pay yourself $0.00 in salary. Many big company CEOs have done this and the IRS didn't jail them. If you get audited, tell them you believe in getting paid for performance, not getting paid for showing up. Any S-corp profit you earn has to be distributed and taxed anyway, so you're not doing anything illegal or unethical. The flip side is you're not paying FICA taxes, and when it comes time to retire or become disabled, your Social Security benefit is smaller. >>

i dont think that flies. the examples you cite has thousands and millions of shareholders - they are not trying to avoid taxes. you on the other hand are.

the irs wont let you get away with it.

Yeah I agree with mshen - if the law says "reasonable" salary, and we pay ourselves zero - I think we'll get in trouble with uncle sam... We're opting for 50/50 salary/dividends so at least we save self-employment tax on half.

Take the rubber bands off your wallet get some advice from a competant CPA who specializes in corporate taxes.

I have an S-Corp and pay myself a base monthly salary to cover my personal month-to-month bills. At the end of the year, I take the portion of the profit as a distribution. I have an Equity account in my accounting software called "Distributions" that I use to record this stuff. My CPA uses my accounting info to generate my K-1 and file my tax return.

Although you save FICA with a distribution, I'm not sure if that has any impact on the amount of money you can contribute to a corporate-sponsored pension plan. I try to max out my contribution based on my salary (25% in 2002) for my SEP.

TannerP:

You said:
I can't find the line where I put the dividends paid to the shareholders. Can you point me in the right direction?
>>> I wish I could put my hands on one of my old 1120S so that I could say with 100% certainty, but they are in storage right now. I looked at 1120S and feel fairly certain that Schedule K's line 4b is the place. I quite recall placing on 4a the amount of interest that came into the S-corp (all of which is forwarded out to the shareholders) and then placing on 4b the total amount of "distributions" to the shareholders, which are, after all, ordinary dividends.


You said:
As far as I understand if we're paying half of the income to the corporate officers and the rest we're distributing to the shareholders (which are the same in this case) the corporation shouldn't owe any income tax whatsoever? (besides the payroll taxes). Is this the case?
>>> I recall and also see on form 1120S that there are certain situations where an S-corp pays a tax. In my case, and apparently yours, I purposely avoid those situations. My goal and probably yours is to use the S-corp in the simplest way possible (and that for which the S-corp was invented as I understand it). To a) Provide a corporation shield where only its small assets can be sued for in court by slimeballs out there (thus protecting the larger assets of its shareholders), and b) Providing a conduit of income flow that is taxed only once. What it boils down to then at the end can be: The corp pays some officers (and maybe nobody else), it pays some expenses, it passes all interest to the shareholders, and whatever else is "leftover" is paid to shareholders as dividends. My simplistic strategy to define "leftover" has been that corporate assets on January 1 shall equal its assets on December 31 (i.e. after everything is all paid out). If that strategy is followed you never will have your dividends exactly equal your salaries for the proposed 50/50 split. But you can get it to be roughly close. If one year the salaries were a larger than dividends and the next year it reversed, I believe is inconsequential to both you and the IRS. In fact this method seems to me to be real world and defensible in an audit.

Caveat: Somebody on here already said pay a pro for advice. I agree and I did. I am not a pro- just somebody who has done ok with what I learned.

Good luck.

Hello again mshen,

I think you are right when you say:
"i read that if you are a one or two man corporation, giving yourself no salary and dividend only will get you in trouble w/ the irs."

I looked over what I had written. There I was distinguishing "Compensation of Officers" from salaries. These two (in my case anyway and perhaps most S-corp users) are both FICA taxed, unemployment taxed, and in every expensive way treated the same. Now in addition to those two payouts and the interest pass through of the S corp, an additional amount can be paid out as dividends. I have heard that there is an unspoken acceptable balance of dividend payout to fully taxed Compensation/Salary, beyond which the IRS would investigate. I think different people have different opinions about what that acceptable ratio is, and there is the fun of it! Anyway we can be certain that declaring 0% compensation/salary to 100% dividends is going to cost you money at the IRS.

Penguinator this is great, you're the first person I've been able to talk to who has actually done this!

Here is one thing that a friend of mine who is NOT an expert brought up. He mentioned that if we pay ourselves a different salary every month depending on our revenues, it may look strange to the IRS. Especially if the numbers come out to be exactly 50/50 at the end of the year. He suggested to pick a flat salary that seems reasonable (25k?) and stick with it. Then write the rest off as corporate distributions, no matter how much income we make. Any input on either of these strategies?

Great thread . . .I'm currently struggling with the same issue. My business partner and I formed an S-corp about 3 monthes ago. We're now about 2 monthes away from ahving the doors open to the public. Anyway . . .

Our accountant has recommended that we not pay ourselves a salary until after the business starts to make money. Then, when we are ready to draw a salary, each of us only draws enough to max out our retirement plans. The rest of the profit will flow to us in the form of a distribution. Keep in mind that both myself and business partner have full time jobs making decent money that we intend to keep until we can live off the money from the business.

GTI,

What kind of a retirement plan are you using?

I am a tax accountant, and I heavily suggest you get an accountant to advise you. Every company is different, and a CPA needs to look at your numbers to advise you. I read some of the responses from other members and they are only getting it half right. Its way too complicated to go into detail on here with out seeing your numbers. Get a Cpa to file your 1120S, and you could even do your own 1040 from the K-1 that is generated (if you wanted to save money).

TannerP:

Again somone mentioned to go pay a professional in the world of finance for advice (this time a tax accountant was suggested). Though I converse here, I heartily agree.

I looked again at your information and noticed that you said that your S-corp. would have no assets. Though not a professional in this whole area, I would believe that a corporation without assets looks useless in the sense that it is a legal entity that needs to comply with the financial requirements of its existence and for that it needs its own funds that are administered by its officers. And if it looks useless then one can ask why does it exist? And that question is what you want to avoid having people ask- in particular the IRS prosecuting attorney at your court appearance.

I would suggest (though not a professional in this area- go get one) that your S-corp have assets enough to run its operation. That way the officers (yes I know that it is you and your partner) can authorize payment of every expense as it comes along (and yes I know that this authorization is in the form of signing the corporation check, writing paid on the bill, applying a stamp to the mailing envelope, and storing the bill in your corporate accounting books}.

Here are some of the routine expenses that come along every year for even the most minimal S-corp and that I believe one would expect to see paid by any non-sham organization:

Annual business license paid to the local city or county.

Annual corporation filing expense paid to the state.

Workman's Compensation Payment. The only way for any employer to avoid this (and an S-corp is an employer even if the only employee or employees is/are officers) is to ask the corporation regulatory agency (probably the state) about exemptions.

Sales tax on anything that you actually sell that requires the collection of same. Don't collect and pay this and your corporation could be harshly found to be an entity set up for tax avoidance purposes. While I happen to rarely actually sell a product (because my work is professional services), I have taken the stance to NEVER sell any product in state because I don't want to mess with the paperwork required in that instance in order to properly forward my collected sales tax to the right agency. I have seen people who failed to do this and they paid dearly. I am not sure but it appears that failing in this regard brings out the most rapid investigations and the most virulent investigators.

Annual tax assessor bill paid to the county. I got my first bill (they really do want your money bad enough to search you out and send you a bill) and called these people and explained that I sold nothing, had no inventory, but generated only professional services. To which they said- nobody believes you are running an income generating operation without owning and using something that is an asset of some sort and that asset is what we tax. I said I used a personal computer that was old and of way less than new value. Declare that each year they said and pay tax on it. They asked if it sat on a table and did I sit on a chair to use that computer. You get the drift. So each year my S-corp pays a very few dollars to these people, and so should yours. When you see their rules and regulations and fines and penalties you will see that keeping them happy is well worth this tiny expense. And one thing I make sure of is that anything that can be called inventory is expended on December 31. Like I said I rarely sell something but if I do I make sure that all the raw product that goes into it is gone on Dec 31- I don't want to be hassled with figuring out how to declare and value anything that resembles inventory to the county tax assessor.

Annual state unemployment fees. These people seem to reward you with lower rates if you pay them properly year in and year out. Mess with them and they will hurt you badly.

FICA and Medicare (both employer and the employee share collected from the employee).

Federal Witholding.

Anything I forgot as I speak off the cuff here.


Now you had asked:

"Here is one thing that a friend of mine who is NOT an expert brought up. He mentioned that if we pay ourselves a different salary every month depending on our revenues, it may look strange to the IRS. Especially if the numbers come out to be exactly 50/50 at the end of the year. He suggested to pick a flat salary that seems reasonable (25k?) and stick with it. Then write the rest off as corporate distributions, no matter how much income we make. Any input on either of these strategies?"

I believe you can see from the above that a good answer is that the S-corp needs to operate and exist as a legitimate entity and for that it needs assets and funds in order to comply with all the regulations under which it operates. To that extent then, the corporation uses its assets to comply throughout the year. And it pays its employees along the way. And this. And that. And, oh yeah, it from time to time declares and issues dividends.

Now of course the S-corp, from its income stream, continually replenishes its expended assets for paying out any of the above. Without that it cannot remain a legal entity for long. The legal existence of the entity is paramount to your argument that money is distributed as dividends. Anything of a sham nature (like not paying those things listed above) places the corporation in legal jeapordy.

And that means that the S-corp. needs assets. It also means that if income is light or non-existant that the S-corp. continues to pay its legal obligations. One has to be willing to see that there will be times when the dividend payout is light or 0, and other times when the divident payout is lf a large amount. This is the proper way to look at your entire S-corp. operation.

No time to check what I said. Gotta run. No doubt pay someone for real information.

Good luck.

Penguinator,

I appreciate your lengthy post. I agree with everyone when they say to hire a professional tax accountant. I do, however, enjoy discussing these issues here as I can learn more and more what is going on, and what questions to ask to make sure the right things are going on.

As far as the assets of the corporation go, I don't really know what assets I would have other than a computer and a corporate checking account. I would assume these would be sufficient to qualify as "legitimate." I overlooked this in my previous post.

I also agree with your comments on the typical costs of a corporation. I think I have the payroll taxes etc. pretty much under control, with the exception of the county tax assessors. I haven't had my run-in with them yet, and since I also sell nothing in my business I assume I will just pay the minimal amount for the small equipment I have (computer,office furniture, etc.) That's good to know that I can look forward to that bill <img src="i/expressions/face-icon-small-smile.gif"border=0> I also avoid the sales tax hassle.

I think I have most of my questions answered for right now... I'm going to run all of this by my CPA, and I'll definitely update this thread if I find something new.

Thanks again for your help

One quick question regarding inventory past Dec. 31, how is tax calucalted, on the actual value or what you have paid for it.

Perhaps you can poke holes in my plan. I plan to open a s corp and operate, create a profit and before the end of the year I purchase a large quantity of product. It usually takes 1 month to arrive (I am importing) so ... in short will I have to pay taxes on product that I have payed for but do not yet have?

Property tax is set by your local town right?

I just want to emphasize 3 points:

1. I hope you and your co-owner has subscribed and paid for shares in the S Corp., which in turn has issued share to its shareholders -- a corporate formality.

2. Dividends/distributions MUST be declared and paid on a per-share basis -- i.e. in proportion to your ownership of the S-Corp. e.g. if you own 60%, then you must receive 60% of the total dividend paid, regardless of how you pay yourself in salaries.

3. It appears that you have very little capital invested in the S-Corp. A "large" dividend -- relative to your salaries may raise a red flag in terms of reasonable compensation.



TannerP said:

<< Penguinator,

I appreciate your lengthy post. I agree with everyone when they say to hire a professional tax accountant. I do, however, enjoy discussing these issues here as I can learn more and more what is going on, and what questions to ask to make sure the right things are going on.

As far as the assets of the corporation go, I don't really know what assets I would have other than a computer and a corporate checking account. I would assume these would be sufficient to qualify as "legitimate." I overlooked this in my previous post.

I also agree with your comments on the typical costs of a corporation. I think I have the payroll taxes etc. pretty much under control, with the exception of the county tax assessors. I haven't had my run-in with them yet, and since I also sell nothing in my business I assume I will just pay the minimal amount for the small equipment I have (computer,office furniture, etc.) That's good to know that I can look forward to that bill <img src="i/expressions/face-icon-small-smile.gif"border=0> I also avoid the sales tax hassle.

I think I have most of my questions answered for right now... I'm going to run all of this by my CPA, and I'll definitely update this thread if I find something new.

Thanks again for your help
>>


fat9wallet said:

<< I just want to emphasize 3 points:

1. I hope you and your co-owner has subscribed and paid for shares in the S Corp., which in turn has issued share to its shareholders -- a corporate formality.

2. Dividends/distributions MUST be declared and paid on a per-share basis -- i.e. in proportion to your ownership of the S-Corp. e.g. if you own 60%, then you must receive 60% of the total dividend paid, regardless of how you pay yourself in salaries.

3. It appears that you have very little capital invested in the S-Corp. A "large" dividend -- relative to your salaries may raise a red flag in terms of reasonable compensation.
>>



fat9wallet,
Thanks for the pointers. Yes, we purchased shares in the s-corp at a 50/50 ratio and plan on splitting the dividends accordingly.

As far as the red flag goes about compensation, that seems to be the tricky part with this strategy. I'm uncertain whether a flat salary is better, or a "floating" salary such as 40% salary / 60% dividend or vice versa would be more convincing to legitimize the entity. Right now I'm leaning towards paying 24k/year to each of us partners. We expect to earn 120k profits/year. That would bring the declared salary to 48k and the dividend to about 72k - so it would be about a 1/3 salary to 2/3 distribution ratio. Again, this is only in the planning stages, but that's where I am at right now.

Two miscellaneous thoughts

When I had a computer consulting corporation in Texas, you were required to collect sales tax on any programming projects since they considered you to be creating a product (just like if I wrote packaged software). However maintenance on the software was not taxable. My tax person made sure that all my invoices made it clear that I was billing for maintenance (when I was doing that).

The other random thought is that, if you have documentation on the salary ranges for the jobs that you are performing and that you are paying yourself in that range, even the low end, you should not have as many problems. I don't think that the IRS is quite ready to handle these lower dividend rates and the changes that they will bring.

But of course, get professional advice.

TannerP said:

<< fat9wallet said:

<< I just want to emphasize 3 points:

1. I hope you and your co-owner has subscribed and paid for shares in the S Corp., which in turn has issued share to its shareholders -- a corporate formality.

2. Dividends/distributions MUST be declared and paid on a per-share basis -- i.e. in proportion to your ownership of the S-Corp. e.g. if you own 60%, then you must receive 60% of the total dividend paid, regardless of how you pay yourself in salaries.

3. It appears that you have very little capital invested in the S-Corp. A "large" dividend -- relative to your salaries may raise a red flag in terms of reasonable compensation.
>>



fat9wallet,
Thanks for the pointers. Yes, we purchased shares in the s-corp at a 50/50 ratio and plan on splitting the dividends accordingly.

As far as the red flag goes about compensation, that seems to be the tricky part with this strategy. I'm uncertain whether a flat salary is better, or a "floating" salary such as 40% salary / 60% dividend or vice versa would be more convincing to legitimize the entity. Right now I'm leaning towards paying 24k/year to each of us partners. We expect to earn 120k profits/year. That would bring the declared salary to 48k and the dividend to about 72k - so it would be about a 1/3 salary to 2/3 distribution ratio. Again, this is only in the planning stages, but that's where I am at right now.
>>


I meant the reverse -- higher salary, lower dividend -- because you have little invested capital and no non-owner employees. As an earlier poster mentioned, you should also take into account the fact that the amount of money that you can put into a retirement plan is dependant on your "earned" income (salary/wage).

I would go with a fixed salary; or a fixed rate per hour billed -- the later option may mean that you and your partner would get paid different amount of salary.



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