1. Money

Discuss in my forum

William Perez

Must S-Corporations really pay salaries to the owners?

By June 16, 2006

Follow me on:

Today's tax question comes from "Aspire," who is starting his own business. He asks:

"Hi William, My wife has just started a business and has decied to go S -Corp. I've read a lot of what you have written about how S Corps work. You have written: 'As an owner-employee of the S-Corp, you will have to pay yourself a salary, and pay payroll taxes on your salary, even if the S-Corp loses money.' Is this still the case if we don't take any distributions from the corporation this year in addition to the fact that we will probably have a loss?

IRS Headliner Volume 32 from Dec 2002 states: 'An S Corporation must pay reasonable compensation (subject to employment taxes) to shareholder-employee(s) in return for the services that the employee provides to the corporation, before a non-wage distributions may be made to that shareholder-employee.' I read this as saying if there are no non-wage distributions there does not have to be any salary/payroll.

Am I wrong, and if so, what am I missing? Thanks!"


An owner of an S-corporation might wear two hats. One is as the owner of the business, entitled to receive a share of the net profits of the business. Oftentimes, the owner will also work for the business, and thus be an employee of the firm. Thus an owner-employee of an S-corporation can receive two different types of income: net profits (or losses) and salary income.

Your reading of the IRS headliner is quite ingenious. It's clear that the IRS is analyzing the situation in which the S-corporation is prepared to distribute funds to an owner-employee, and the IRS is saying before profits can be distributed, the S-corporation must first determine to what extend any of those funds represent compensation for services rendered as an employee. Your question is whether salary must still be paid even if there are no distributions to be made to the owners.

I think that's a complex question. The clearest guidance I can find is in the fact sheet, "Wage Compensation for S Corporation Officers" (FS-2008-25). There the IRS lays out the following two-step thought process:

  1. "Generally, an officer of a corporation is an employee of the corporation." This implies an employee-employer relationship between a corporate officer (such as President, CEO, etc.) and the corporation. In a small S-corporation, the officer could also be the shareholder. So this same person would have two distinct roles: that of a shareholder and that of an employee.
  2. "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 services rendered to the corporation" Here the IRS is saying the same thing as it said above in the headliner: that the S-corporation must determine the extent to which payments to a shareholder-employee are treated as salary and the remainder can be treated as distributions of net profit.

Later on in the same fact sheet, the IRS makes the intriguing comment, "The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly." This statement may correspond to your own interpretation.

However, I have some deep reservations about these statements from the IRS. If shareholders working for their own S-corporation really are employees, then it logically follows that employees must be paid some sort of wage. Of course, tax rules are not always logical, but I think this would be a reasonable extension of the IRS's own line of thinking.

The real difficulty comes when a company is just starting out, such as your wife's business. Generally, businesses go through two or three lean years, sometimes losing money and sometimes breaking even. After a few years the business will either close or begin making profits. This is a cycle I have seen over and over again with my clients. In the startup years, the owners often tap their own savings and investments to keep the business afloat. And so it strikes many people as silly that they take their own money out of their savings account, put it into their own business, and then pay themselves a salary, plus the various payroll taxes, with their own money.

For your wife, she should consult with a tax professional with solid experience in small business taxes and find out what her alternatives are. An honest examination of the cash-flow projections for the business might point to a solution that will be defensible before the IRS and help put the business on solid financial footing.

More about:

Revised 6/11/2012

June 21, 2006 at 11:09 am
(1) Don says:

Regarding “Must S-Corporations really pay salaries to the owners?”, does the same apply to LLC’s? Don

August 14, 2007 at 3:30 pm
(2) Ivan Stanojevic says:

I disagree after reading your IRS excerpt. This is the key right here “An S Corporation must pay reasonable compensation.., before a non-wage distributions may be made to that shareholder-employee”. An S-corp can choose not to pay an owner/employee but the owner/employee can not take a profit without first being paid a reasonable salary. So an S-corp is still a perfectly reasonable vehicle for a new company without any profits.

October 16, 2007 at 10:40 am
(3) JP says:

I agree with Ivan.

The excerpt is simply saying: If compensation is going out the door, then SE tax better be going with it.

And yes, there are plenty of people of means that take $0 salaries from startup companies while it is cash-flow negative. In fact, I don’t know why anyone would think there’s a requirement to pay SE tax on a cash-flow negative biz. Would you care to elaborate on your point of view? (Code cit. would be a good idea.)

February 2, 2009 at 12:46 pm
(4) Peter says:

How is the IRS going to say that an S corp losing money needs to take officer salaries/reasonable compensation? The concept is S/E tax-related, of course. So, if a partnership is losing money and the active partners have no income (only losses) to report, should there be some ridiculous calculation to make sure the partners pay some kind of S/E tax? Sorry to call you out, but you’re wrong. If an S corp is losing $$$, there is no requirement to pay “reasonable compensation” when an entity is not making money. By it’s very definition, compensation would not be considered “reasonable” if the entity is losing money? By it’s very nature, compensation is “income”. No income, means no compensation and no S/E tax exposure.

February 13, 2009 at 11:32 am
(5) Ben says:

William, in the link you gave the IRS states right on the fact sheet “The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly” Meaning you don’t have to pay SS taxes if your business didn’t make any money. Granted if you gross $500,000 and manage to write it all off the IRS will probably come back and say you had indirect wages and need to pay SS tax, but for a startup that truly lost money they wont have to pay FICA/FUTA taxes.

March 14, 2009 at 10:45 pm
(6) David says:

It seems to me from my research thus far and the United States supreme court rulings that legally if you own all shares of the Corperation and have absolute control of the entity. You could fairly argue, rightly, that you are the owner of said corporation and as the proprietor you are not in point of fact an employee subject to salary requirements. This of course would only apply to total ownership of the shares. Any situation where someone else within that entity could effect the action of the company would disqualify the argument of ownership. Legally it is refered to as “the right to control”. The IRS may not recognize it universally but I suspect they haven’t had additional arbitration related to the issue.

November 15, 2009 at 9:27 pm
(7) Randy says:

The easy way to circumvent the entire issue is to form an LLC, not an S-Corp. There is no requirement for the “members” of LLCs to take “guaranteed payments.” In a subsquent year, when the LLC is making money, you can file forms with the IRS to elect to have your LLC treated as an S-corp for purposes of taxation. I did this myself. Most states will follow how the IRS treats you when you notify them. I have done this for my company, operating in Utah, California, and New Mexico.

If you really insist on forming as S-corp, write to the IRS and request a written response.

September 6, 2010 at 6:26 pm
(8) KL says:

What if your S Corp is not your sole income? What if you have a full time job & you start an S Corp. Do you still have to pay yourself even if there is no profit & you are losing money?

April 1, 2011 at 3:01 pm
(9) JT says:

This article is incorrect and extremely misleading… I would highly recommend removing it from the web.

The position of the IRS is that “The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly.”

I am the sole owner/employee of an S-Corp… It is asinine to think that the IRS would require me to pay myself a “reasonable compensation” if my S-Corp is operating at a net loss. Are they going to make me take out a loan to pay myself and the associated payroll taxes? No!

The IRS only cares about how I classify my net profit for the year… A portion will be classified as Wages (subject to SE Taxes) and a portion will be classified as Income from S-Corp (not subject to SE Tax).

The purpose of the “reasonable compensation” requirement from the IRS is to prevent me from avoiding Self Employment Tax by classifying “too much” of my net profit as Income from S-Corp.

The IRS could care less if I actually pay myself regularly… Really, how many small business owners actually cut themselves a paycheck? Not many. All the IRS cares about is how I classify my net profit at the end of the year.

April 1, 2011 at 6:22 pm
(10) William Perez says:

JT, you raise an important point, namely that corporations can have loss years and so meeting payroll obligations would pose an additional financial burden on the business. I understand that. What the IRS seems to be looking at are the FICA payroll taxes, and also at the 100% penalty for not paying FICA taxes. In other words, this a relatively easy target for the IRS if they are auditing an S-corporation. I do want to point out also that shareholders of an S-corporation who also work for the S-corporation are employees, and so they are subject to the FICA rules instead of the self-employment tax. Sure, both result in the same pay-in to Social Security and Medicare, but the two systems have different reporting requirements and penalty structures.

June 7, 2011 at 6:12 pm
(11) Alexander says:

I’m very doubtful about the legitimacy of this advice as well. I’m an attorney, and I’ve seen no evidence that the Internal Revenue Code requires S-Corps to pay compensation to owners even when there are no net earnings.

It would be illogical to owe payroll taxes on a business that’s losing money merely because you incorporated it. A sole proprietor whose business expenses exceed revenues does NOT pay self-employment tax. Unless I see a Code section or case holding showing that a nonprofitable S-Corp must pay wages, I’m going to disregard this article.

November 12, 2011 at 4:35 am
(12) Steven H Enrolled Agent says:

I’m licensed by the department of treasury and have researched this thoroughly. The IRS will NEVER penalize you for not making any money. Think of this as a large Schedule C business. If there is not income there are no wages earned. Now if the loss is only on paper due to depreciation… etc. Then the owner better be paying a salary to themselves.

So to put an end to this never ending conversation. This article is WRONG.

January 2, 2012 at 8:22 pm
(13) julie says:

I have an S-corp for my 3 rental properties. It has not made a net profit yet, so based on these comments, I might be okay not having paid salary to myself yet. However, if I start to make a net profit, if I have ONLY passive income, do I still need to pay myself a salary?

January 3, 2012 at 1:03 am
(14) William Perez says:

S-corporations holding rental real estate is a special case. Generally speaking, the compensation issue boils down to an analysis of whether your rental activities as passive or active income. You’ll need to consult with a knowledgeable tax professional for a more tailored analysis of your particular situation.

January 6, 2012 at 8:32 pm
(15) The guy says:

Would the author of this article please retract his advice that owners of S corps are required to pay themselves regardless of whether they make a profit?

I read this a few months ago and (having just started an s-Corp), I literally lost sleep over it until my tax accountant, who has been a CPA for over 29 years, assured me that I would only have to pay myself a salary if the business actually makes a profit, and that this article is just plain wrong.

In my case, that may be awhile as I am still working full time for another company while I get my business started.

January 7, 2012 at 6:36 pm
(16) William Perez says:

I understand your disagreements, the guy. But here’s what I’m worried about. The IRS has been saying over and over that officer-shareholders of an S-corporation are employees of the S-corporation. If what the IRS is saying is right, then it logically follows that officer-shareholders must be treated as employees; that is, must be paid at least minimum wage, and that all other labor laws would apply as well. Since I’m not an attorney, I cannot give legal advice. But similarly I cannot give advice contrary to known laws. Employees do have to be paid, I think we can all agree on that. This is why I no longer think S-corporations are a good vehicle for new ventures. It’s better to start out as a sole proprietor or partnership or LLC, since there aren’t the sort of employment tax issues involved.

January 10, 2012 at 5:56 pm
(17) Louis says:

William. Where did you get your business experienc

January 10, 2012 at 6:00 pm
(18) Louis says:

William…William…William… As someone said earlier, as long as you classify a reasonable amount of your profits as wages. You do not have to take a salary if you are not profitable. and to forego incorporating altogether is worse advice. How about if you start as a sole prop and get sued the very first time out. BANG!!! your dreams of entreprenuership are over!!!

January 10, 2012 at 7:03 pm
(19) the guy says:

Both my attorney and my accountant advised me that the S corp is the best way to go. (in my situation) The only negative associated with choosing S- Corp is there is more paperwork.

As far as William’s arguement above about having to pay yourself at least minimum wage because of the irs considering an officer/shareholder as an “employee”, minimum wage laws do not apply to companies with less than $500,000 of business. (I posted this earlier and it got deleted somehow.)

I suggest, if William won’t back off his position, this article should be removed completely. It’s irresponsible to have the public be mislead by this.

February 1, 2012 at 9:20 pm
(20) JD says:

I JUST RESEARCH THE IRS WEB SITE AND THE ANSWER TO THEIS QUESTION IS CLEARLY RESPONDED IN THE FOLLOWING STATEMENT BY THE IRS ” If cash or property, or the right to receive either, did go to the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate. See the S Corporation Compensation and Medical Insurance Issues page for more details on what is considered to be reasonable compensation.”

THEY KEY PART “If cash or property, or the right to receive either, did go to the shareholder,” IF…..

DONT BELIEVE ME LOOK THE LAST PARAGRAPH HERE: http://www.irs.gov/businesses/small/article/0,,id=203099,00.html


February 10, 2012 at 4:45 pm
(21) Nadine says:

I want to ask the poster of this article by what means an S-corp owner is supposed get a salary from if there is no income. A bank will not give a loan to someone to pay themselves who says they have no income to pay the loan back. Where is the person supposed to get the money from to pay himself….take out a cash advance on a credit card? Aren’t taxes paid on earned income….not no income?

March 7, 2012 at 2:30 pm
(22) Sheryl says:

Wow! This has me really confused! I started a new business the beginning of this year. It’s an LLC, but taxed as an S-Corp on the advice of my accountant. I’m pretty sure at this point that it was not good advice. I have about $25K into the business so far and am running out of money! Now I’m being told, by my accountant, that I have to pay myself a salary, at least 44 hours per week at minimum wage (that’s the hours my business is open)! Just on paper of course, because my business is losing money every month so far. That means I have to pay taxes and unemployment insurance on $17,343 this year, even if my business doesn’t make a penny! Does the government WANT new businesses to fail? I’m retired military, and my pension keeps me from drawing unemployment in any case, so I’m paying for something that I can never use! I was prepared to not make money… possibly for years, but I simply can’t afford the extra $215 each month. I’m considering closing shop before it even has a chance. I want to believe those of you who say that you don’t have to draw a salary if you don’t make a profit, but if you’re wrong, 100% penalty… I’ve already lost almost everything I had saved…

April 8, 2012 at 9:10 pm
(23) Leigh says:

Here’s where I get confused. On my 1120S, I put the money I’ve taken out of the business for personal use (under $20k) as Compensation Of Officer. I then pay a Self-Employment tax on that amount on my 1040.

But I don’t issue myself a W-2 or do anything else. Isn’t this okay?
I pay the Self-Employment Tax. I declare the profit of the business (under $10k) on my 1040 which counts as income. Seems to me that the IRS is getting all the money they would normally get – correct?

Someone please tell me if I’ve totally made a mess of this for the past 9 years!

June 5, 2012 at 12:25 pm
(24) JDW says:

I own an S-Corp and what has happened here is William spoke to soon and got called out and now he donít know how to say, he is wrong. If a company is not making any gross income, then there is obviously no money to be paid out at all. And the comments like (Would you work for free?) and (Would you take a job making less than min wage?) are just ridiculous.. Of course, people that start their own businesses work for free all the time. You have to until you’re making money. If William was right, then I want to sue myself for not paying me when I didnít have any money. And I want to sue the IRS for not telling me sooner that I needed to sue myself. Maybe that would have saved having to struggle for a few years. Maybe William can tell me if I can sue myself now for the back pay or just some extra income. Here is a bit more “William like” advice, if your business is struggling. If you own a catering business and you donít have any customers, then cook yourself something to eat. If you’re a mechanic and need more work, then work on your own car. I donít know why I didnít think of this myself.. My school needed more enrollments, but I didnít know I could just sit in class and teach myself, and enrollment would be increased.. This is awesome, thanks Willie!

January 29, 2013 at 1:39 pm
(25) DLPA3 says:

This article and line of comments makes me sad! There are some assumptions being made that are leading to lines of argument that are way off and irrelevant.

One. Company shareholders in an S-Corp performing employee-like duties are classified “shareholder-employee” not straight “employee”. It’s a totally different situation, and laws that apply to “employees” do not apply to “shareholder-employees” by default, including minimum wages. Two separate classifications. There’s a third, too: straight “shareholder” (one who does not act as an employee, only an investor).

Two. Shareholder-employees do not have to be paid a wage (at all!). However, if the company has retained earnings that it wants to distribute to shareholder-employees (versus keeping it to increase the company’s assets/balance sheet), it CANNOT do that unless those shareholder-employees were paid a reasonable wage for their services during the profitable period.

So, for example, if the company was quite profitable in Q1 and Q3 but was slightly in the red for Q2 and Q4, resulting in an overall profit for the year, when the company goes to pay those distributions at the end of the year, it just has to check the books to ensure that the shareholder-employees were paid reasonable wages in Q1 and Q3 – which also means that payroll taxes had to have been paid for those quarters, or you’ll be penalized for paying those payroll taxes late. Keep good, accurate books, and plan ahead, and remember to take a hard look at each quarter rather than just the yearly numbers. Rule of thumb: The IRS wants it’s taxes, and they want it at the right time, according to what actually happened, not according to where the numbers were moved to later on.

The first moment you start turning a profit and might be ready to pay yourself a wage, absolutely get a CPA or at least an Enrolled Agent (EA) to help with your tax planning – even if it’s the middle of the year, like July.

April 1, 2013 at 4:26 pm
(26) Chefjuan says:

Wow. I just read ALL of these postings and one thing is for certain, this is not a black and white issue. I and a partner just opened a new restaurant which is not even 1 yr old. We are managing to pay our staff and bills but have yet to actually profit on the venture and do not expect to yet for some time. We, under the assumption that it wasn’t necessary, are shareholder employees, have not paid income taxes yet for this year because of the fact that our business has yet to be profitable. We are now preparing our business taxes and are trying to figure out how best to file our own personal taxes. It seems as though because we have not had the ability to take any money as profit yet, it is then also not necessary or even feasable to be paying ourselves a salary (and believe me, just look at my bills, I have not been making a salary) so in all reality I should just be filing an 1120s correct? Do I need to file a 1040 as well? please advise.

Also, I would like to thank everyone for the really great conversation. The s-corp was also recommended to us for a great way to start a protected partnership however now just finishing our first year, it seems like the tax aspect of it was wayyy more complex then just starting a LLC.

As added incentive, I’ll make dinner for two for anyone who can give me the correct advice in this matter. I seriously will.

April 2, 2013 at 2:14 am
(27) William Perez says:

Seek the advice of a certified public accountant or enrolled agent who specializes in S-corporations. They will be able to review your situation and advise you appropriately.

April 12, 2013 at 5:17 pm
(28) DAVEP says:

TRY THIS I DONT EVEN WORK FOR MY DADS COMPANY BUT HE WRITES ME A Payroll CHECK OUT THEN HE CASHES IT A GIVE’s ME HALF OF THE CHECK AMOUNT. And a w-2 without subtracting the half he kept .I get screwed for who the irs and my dad

April 12, 2013 at 7:20 pm

MY FATHER owns a s-corps he makes a payroll check in my name then cashes it himself .keeps half the money then hands me a 1099 at the end of year for full amount .what’s going on F@!#? s-corps

April 14, 2013 at 4:27 pm
(30) William Perez says:

Have you asked your father to issue you a statement showing how much tax was withheld so you can claim that withholding on your tax return? If your father is unwilling to provide that, you might want to talk to the IRS about this so you can receive some guidance on what to do next.

January 7, 2014 at 3:25 pm
(31) qt says:

I own an S-corp myself and have never liked dealing with the paperwork.

I understand everyone’s point of view here, and I know it seems ridiculous, but I think the IRS does in fact require you to pay a salary… unless you want to get audited. The rules aren’t very clear so there’s room to argue both sides. But if you want to err on the side of caution, keep in mind that:

1) They specifically check your officer compensation and if it’s $0, they may audit you.
2) If you report $0 profit for more than 2 years in a 5 year period, they may audit you.

Ideally, you are expected to pull a profit every year and pay yourself a reasonable salary for the work you do. So if you “Manage a Restaurant” you should be getting paid a manager’s salary.

You MAY be able to get away with zero profit and zero salary the first year or two, but there’s still a chance you get audited. You will certainly get audited in the third year if you still don’t pull a profit or pay yourself a salary.

Now, once they audit you and find that you’re really making zero money, there’s no fraud going on, and all your books are 100% accurate… they may not penalize you. Do you really want to get audited and find out?

If you’re starting a business with high expenses and delayed profit return, you’d be better advised to start an LLC. If you are starting a business with high legal risk and low startup cost, then an S-corp is probably better. Or, you can start out self-employed and just pay the SE tax until you build up a client base – then incorporate when you’re ready.

February 27, 2014 at 11:38 pm
(32) vic says:

Bad advice. No way will I take money I have earned and payed taxes and FICA on once…put it into the money losing S corp and then pay taxes and SS again? Have you lost your mind here? No one in their right mind would ever do this.

Leave a Comment

Line and paragraph breaks are automatic. Some HTML allowed: <a href="" title="">, <b>, <i>, <strike>

©2014 About.com. All rights reserved.