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Paying a salary in a S-corporation - who gets the salary? Social Security tax liability question.

Seattle, WA |

I have a S-Corporation registered in Washington state.

I will be working as a contractor for another company and the wages will be made payable to the S-Corporation using the S-Corporation's tax ID number. I would like my wife to receive the salary while I receive none. Is this possible without violating the reasonable salary rule? For example, if the contract work (which I will be performing) will gross $100,000 this year, the S-corporation will pay my wife $70,000 in salary with the remaining distributed to me in the form of dividends. The reason for this strategy is that I do not wish to report any wages on my Social Security number. I am not sure if the IRS has any way of knowing who is actually performing the work (since the wages are reported in the company's name and TIN).

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Attorney answers 1


Your question and planning is very common. In general, an S corporation has some flexibility to pay out distributions as well as salary. But be careful and always remember the old tax attorney saying "pigs get slaughtered when they become hogs." The IRS is very focused on this issue - really the flip side of the old "reasonable comp" issue with C Corporations (where the incentive is to pay everything out as salary to avoid double taxation of non-deductible dividends). They have been ever since the first case against a Milwaukee attorney who tried to pay everything out as a distribution (i.e. he was a hog).

I'm not sure why you would choose to pay all salary to your wife and none to yourself if you are doing the actual work on behalf of the S corporation. For one thing, that impacts your SS earnings. But also, it looks hinky. The rule of thumb is that if you provide services to the S corporation it must pay you for the market value of those services. What services is your wife providing?

My suggestion instead would be to pay a salary to yourself for the value of your services. This is what a third party business owner would pay you if he or she hired you, in order to generate a profit to the S corporation owners. The safest way to support your salary number would be to have an independent evaluation by someone like the Mercer company. A less thorough method would be to survay the classifieds to see what employers are offering to pay people doing your line of work with your experience level.

I can't say the 70% level is right in your case. That depends on the value of your services. It's a judgment call. But theoretically no owner, including yourself, would hire you to perform services that would only enable the owner to break even. When you wear your owner hat you are entitled to treat part of the earnings as profits, as long as you would be operating at a profit if you hred someone else to do the services.

Incidentally, if your wife is performing services, she should be paid salary as well.

And don't forget, you might be better off, if paid the same amount, being treated as an employee by the client. That way you only pay half the federal employment taxes, none of the L&I or EmSec, and no B&O tax.

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