Must an S Corporation Pay Wages to Its Shareholders?

by James F. Scully, Jr. 

Does an S corporation without employees have to pay wages to its officers who are also shareholders of the company?

If you treat the officers as employees for employment tax purposes, then, yes, you must pay the officers a wage. Usually, the IRS considers a corporate officer an employee if the officer performs substantial services for the company. For example, the officer regularly stocks shelves with retail items. But if the officer performs no services or only minimal services for which she isn't paid, then the officer is not considered an employee. For example, an officer who just votes her shares or is occasionally consulted for advice for which she is not paid would not be considered an employee.

The IRS may reclassify a distribution to an S corporation officer-shareholder as wages if the officer performs substantial services for the corporation. If the IRS reclassifies the distribution, the corporation will incur employment tax liabilities, penalties and interest unless it qualifies for relief under Section 530 of the 1978 Revenue Act.

Section 530 allows corporations that improperly classify officers as nonemployees to be relieved of associated tax liabilities if they meet certain conditions. Of course, the corporation and the IRS may not agree on the interpretation of those conditions. So it's a good idea to discuss the matter with an adviser, such as a CPA, who knows the tax laws.

James F. Scully, Jr. is principal of Scully Accountancty Corp. in Thousand Oaks, Calif.  He can be reached at (805) 777-7100.

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