Salary Versus Distribution

A U.S. District Court recently ruled against a S Corporation shareholder whose distributions dwarfed the shareholder’s salary. The ruling allowed the IRS to reclassify dividend payments as salary, causing the reclassified amounts to be subject to employment taxes. The shareholder-employee’s salary was deemed unreasonably low at $24,000 per year in comparison to the $67,000 in dividend distributions made. The courts rejected the shareholder-employee’s argument that the IRS’s recharacterization was an impermissible attempt to impose minimum salary requirement. Rather, the court’s findings based on the facts and circumstances of the case evidenced that the dividend was intended to avoid employment tax. S Corporation shareholder-employees should evaluate their compensation for reasonableness in light of this judgment.

August 2011

Pursuant to IRS Circular 230, the Internal Revenue Service requires us to inform you that any tax advice included herein is not intended or written to be used, and it cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed by the IRS on the taxpayer. That said, please do not hesitate to contact us if you have any further questions regarding this matter.